April 2013

Toroso Investments, LLC

Bond ETFs - Where Is the Income?

Research compiled by Michael Venuto, CIO

Here is a list of the top 25 Fixed Income ETFs in the US by AUM. Excluded from this list are High Yield Bond ETFs,
International Bond ETFs, Active ETFs, Leveraged and Inverse ETFs. I believe this is representative list of the standard fixed
income market of the traditional bond purchaser and represents $157 billion in assets.

iShares Barclays 1-3 Year Credit Bond

iShares Barclays 1-3 Year Treasury Bond
iShares Barclays 20+ Year Treas Bond
iShares Barclays 3-7 Year Treasury Bond
iShares Barclays 7-10 Year Treasury
iShares Barclays Credit Bond
iShares Barclays Interm Govt/Credit Bond
iShares Barclays Intermediate Credit Bd
iShares Barclays MBS Bond
iShares Barclays Short Treasury Bond
iShares Barclays TIPS Bond
iShares Core Total US Bond Market ETF
iShares iBoxx $ Invest Grade Corp Bond
iShares S&P National AMT-Free Muni Bd
PowerShares Build America Bond
PowerShares Insured National Muni Bond
SPDR Barclays Capital Short Term Corp Bd
SPDR Nuveen Barclays Capital Muni Bond
SPDR Nuveen Barclays Capital S/T Muni Bd
Vanguard Interm-Tm Corp Bd Idx ETF
Vanguard Intermediate-Term Bond ETF
Vanguard Long-Term Corp Bond Idx ETF
Vanguard Short-Term Bond ETF
Vanguard Short-Term Corp Bd Idx ETF
Vanguard Total Bond Market ETF

Ticker

Annual Report
Net Expense Ratio

Yield to
Maturity

Prem/Disc
12 Mo Avg

12 Mo
Yield

CSJ
SHY
TLT
IEI
IEF
CFT
GVI
CIU
MBB
SHV
TIP
AGG
LQD
MUB
BAB
PZA
SCPB
TFI
SHM
VCIT
BIV
VCLT
BSV
VCSH
BND

0.20
0.15
0.15
0.15
0.15
0.20
0.20
0.20
0.25
0.14
0.20
0.20
0.15
0.25
0.28
0.28
0.13
0.23
0.20
0.12
0.11
0.12
0.11
0.12
0.10

0.89
0.26
2.82
0.68
1.43
2.49
1.02
1.85
1.40
0.15
1.40
1.49
2.81
1.94
4.90
4.41
1.15
2.72
0.65
2.70
1.82
4.41
0.59
1.37
1.54

0.18
0.01
-0.03
0.02
0.01
0.32
0.21
0.28
0.04
0.01
0.06
0.11
0.50
0.66
0.10
0.14
0.36
-0.03
0.05
0.53
0.24
0.78
0.07
0.37
0.13

1.57
0.37
2.66
0.87
1.79
3.51
2.13
3.16
1.82
0.01
2.21
2.54
3.83
2.89
4.85
4.11
1.46
2.83
1.21
3.24
3.08
4.34
1.56
2.15
2.72

0.18

1.88

0.20

2.44

AVERAGES:
Source: Morningstar Direct January 2013

What is the Net Yield?

So what information can we take from this data set? First, the average stated yield, or current yield (the number on Yahoo
finance and the fact sheets) is 2.44%. Traditional bond buyers are not concerned with current yield (CY) but rather the yield to
maturity (YTM), which is 1.88% in this data set and 23.10% less than the CY. Additionally, the fixed income world remains
somewhat opaque and therefore the average premium investors pay (cost of ETFs exceeding the underlying value of the bonds)
to purchase these ETFs is about 0.20%, which further reduces the net yield to 1.67% or 31.43% off the CY. Then we need to
consider the average expense ratio of 0.18% which gets us to a best-case scenario of 1.49% net yield or 38.93% less than the
current yield of 2.44% that is prominently displayed in the advertising.
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Toroso Investments, LLC

And, this is before trading costs, such as commissions and advisory fees, and inflation adjustments (Note: if inflation
expectations dont increase the real net yield on Shares Barclays TIPS Bond ETF is actually -0.97%). And for one last
comparison, let's look at the current yield of 2.44% and subtract the average discount (0.20%) and average expense ratio
(0.18%) to get a net current yield of 2.06% and compare it to the current yield of SPY (the S&P 500 Index ETF from State Street
Global Advisors) at 2.07%, and the income produced by fixed income ETFs looks pretty bleak.

The Income Barbell Portfolio

The fact that Bond ETFs do not currently offer sufficient yield requires flexible and innovative ways to find reliable sources of
income in disparate markets. One of the techniques to use to meet the challenges of this yield drought is to build an Income
Barbell Portfolio. This structured approach combines unequal weightings of cash and income-oriented investments to
synthetically construct a higher yielding portfolio than investors can find with traditional income investments like bonds or openend bond funds.
Traditionally, when pursuing a bond barbell strategy, you buy short- and long-term bonds only. Theoretically, this provides the
best of both worlds. At the high end of the barbell, you lock in higher rates. On the short end of the barbell, investors have less
interest rate and credit risk. And when short-term bonds mature, investors use their proceeds to reinvest.
Investors often use bond barbell portfolios during periods of rising interest rates or when the prospect of higher rates is
imminent. By investing in the extremes of the income hierarchy, investors have the potential to increase their portfolios overall
return while the short end gives an extra margin of safety against credit defaults and interest rate risk.
However, an Income Barbell Portfolio expands the potential universe of income-oriented investments. One of the more
sophisticated ways to construct the risk end of the Income Barbell is to combine unequal weightings of Exchange Traded
Products (ETPs), closed-end funds, preferred stocks, dividend producing common stocks, REITs and income-oriented MLPs.
Place an emphasis on safety and liquidity at one end of the barbell buying cash equivalents and stretch the envelope at the
other end by investing in higher yielding, riskier income-producing assets.
One of the biggest champions of the barbell strategy is Nassim Taleb, the author of The Black Swan. Taleb believes that all
investors are vulnerable to prediction errors --black swans -- and that most Modern Portfolio Theory (MPT) risk measurement
metrics are fatally flawed. Asset returns are more diversified on the upside and considerably less on the downside -- precisely
the opposite of what most investors desire particularly when financial turbulence strikes.
Nassim Taleb believes investors should be hyper-conservative with most of their monies and hyper-aggressive with a small
portion of their portfolios instead of putting their money in medium risk investments. 1 You put the lions share of investable
funds in extremely defensive assets and the remainder in more speculative income-yielding assets. High cash reserves and very
liquid, short-end maturities on one end coupled with plenty of small bets in the aggressive end of the barbell strategy.
In summary, there are several higher yielding income products that investors can use to cope with a historic Yield Drought. Its in
tough times like the present, that competent and caring financial advisors genuinely earn their keep.

Disclaimer
This commentary is distributed for informational and educational purposes and is not intended to constitute legal, tax, accounting or
investment advice. Any securities discussed are not recommendations, are not offered or being offered for purchase or sale, and are
presented for illustration purposes only. The investment or strategy discussed may not be suitable for all investors. Investors must
make their own decisions based on their specific investment objectives and financial circumstances. While Toroso Investments, LLC
has gathered the information presented from sources that it believes to be reliable, Toroso cannot guarantee the accuracy or
completeness of the information presented and the information presented should not be relied upon as such. Any opinions expressed
in this commentary are Torosos current opinions and do not reflect the opinions of any affiliates. Furthermore, all opinions are current
only as of the time made and are subject to change without notice. Toroso does not have any obligation to provide revised opinions in
the event of changed circumstances. All investment strategies and investments involve risk of loss and nothing within this commentary
should be construed as a guarantee of any specific outcome or profit.

Nassim Nicholas Taleb, The Black Swan: The Impact of the Highly Improbable, Random House, NY 2007, pp.205-06

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