Since the fundamental ETF has been running for only a year, it is too soon to make any conclusive judgments about the approach. But it is clear that the new ETF has a higher credit quality than its cap-weighted competitors.
The average credit quality of Arnott's fund is double-B, one step below investment grade. In contrast,
iShares iBoxx $ High Yield Corporate Bond
, a cap-weighted competitor, has a lower rating of single-B.
During the past year, both high-yield funds have delivered nearly identical returns of 8.7%, according to Morningstar. But the fundamental fund has proved more resilient in difficult times. During the turmoil of the past month, the iShares fund lost 1.8%, while the PowerShares fund stayed in the black, returning 0.4%.
Along with Arnott's fund, another way to avoid cap-weighting is to buy actively managed funds. These have the freedom to focus on quality issuers and avoid the most heavily indebted borrowers.
A top active choice is
Dodge & Cox Income
, a high-quality intermediate fund that aims to outdo the Barclays benchmark.
During the past 10 years, the fund has returned 6.3% annually, compared to 5.9% for the index. In addition to Treasuries, the fund has a big stake in corporate bonds. Issues in the portfolio include bonds from
Bank of America
Another solid active fund is
Janus Flexible Bond
, which has returned 6.7% annually during the past 10 years. The fund can shift its allocations, emphasizing sectors that appear undervalued.
Janus limited losses during the downturn of 2008 by putting 60% of assets in Treasuries.
These days Treasuries seem rich, and the fund has 68% of assets in corporate bonds. Holdings include bonds from
American International Group