Enhancing Yield for the Great White North
As most global bond yields remain near historical lows, the ability for investors to generate income from core fixed income holdings continues to be constrained. Typically, core fixed income benchmarks in many investors’ portfolios are dominated by sizeable exposures to low-yielding government securities. As a result, following such a market capitalization-weighted benchmark generally reduces investors’ ability to produce meaningful yields while also reducing their ability to generate sufficient income from core portfolios.
This is certainly a headwind that fixed income investors have been facing in the sovereign debt universe of the developed markets. More specifically, this remains a challenging landscape for investors in the Canadian bond market. Indeed, following such a market cap-based approach for fixed income investing has also played an important role in limiting Canadian bond investors’ ability to produce income in their overall portfolios.
Typically, in a low-rate environment, investors looking to enhance income potential focus on two distinct methods to achieve the desired result: moving out on the yield curve and/or moving down the credit rating scale. In each instance, fixed income investors are introducing additional layers of risk to their portfolios: interest rate risk and/or credit risk.
Against this backdrop, WisdomTree worked to create an approach to enhance yield while maintaining a risk profile similar to what an investor would encounter by following a market cap-based benchmark, such as the Bloomberg Barclays Canadian Aggregate Index (CAD Agg). The Bloomberg Barclays Canadian Aggregate Enhanced Yield Index (CAD Agg Enhanced Yield) uses a rules-based approach to reallocate across sectors in the CAD Agg in order to achieve the two aforementioned goals. Yield can typically be increased by shifting exposure along any of a number of different risk dimensions, including sector exposure (Treasury, government related, credit), interest rate risk (duration) and credit risk.
Rules-Based Approach for Canadian Agg Enhanced Yield
In summary, the WisdomTree approach utilizes a constraint guideline that can reallocate the weights by major sector within a +/-20% threshold of the CAD Agg while also adhering to a duration cap of no more than one year. This same methodology was also applied to the one- to five-year segment of the CAD Agg (CAD Short Agg Composite). The Bloomberg Barclays Canadian Short Aggregate Enhanced Yield Index (CAD Short Agg Enhanced Yield) employs weight constraints of +/-30% by major sector with a duration cap of +0.5 years.
Sector Snapshots of the Canadian Agg Enhanced Yield Index & Canadian Short Agg Enhanced Yield Index
As the above bar chart clearly illustrates, this reweighting of the CAD Agg generally produces over-weights in credit and under-weights in Treasuries. The net result is that investors will have the potential for higher income as exposure to historically low government yields is reduced accordingly.
In our opinion, the WisdomTree Yield Enhanced Canada Aggregate Bond Index ETF (CAGG), which seeks to track the price and yield performance of the Bloomberg Barclays Canadian Aggregate Enhanced Yield Index before fees and expenses, provides a solution for income-oriented investors who are looking to pragmatically enhance yield in their portfolios and can be considered an integral part of a core fixed income strategy. For investors who are focusing on reducing interest rate risk, the WisdomTree Yield Enhanced Canada Short-Term Aggregate Bond Index ETF (CAGS), which seeks to track the price and yield performance of the Bloomberg Barclays Canadian Short Aggregate Enhanced Yield Index before fees and expenses, offers a solution that not only tilts toward income, but also can be used as either a core approach or a complement for a fixed income portfolio.