Why is US govt obligation %age so different between BND and AGG?


R

Rich Carreiro

AGG tracks the "Barclays Capital U.S. Aggregate Bond Index"
BND tracks the "Barclays Capital U.S. Aggregate Float-Adjusted Bond Index"

(but from what's on the Barclays Capital website, those two indexes
are very similar.)

And of course each ETF's advisor has its own sampling strategy. Still
-- 6.57% of AGG's income is from US govt obligations while 26.57% of
BND's is from US govt obligations.

However, AGG lists Treasuries holdings of 35.62% vs. BND's 43.1% which
isn't that big a difference, so why the big difference in US govt
income percentages? Is it just sampling differences, with Vanguard
weighting higher-coupon Treasuries more in their scheme?
 
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M

Mark Freeland

AGG tracks the "Barclays Capital U.S. Aggregate Bond Index"
BND tracks the "Barclays Capital U.S. Aggregate Float-Adjusted Bond Index"

(but from what's on the Barclays Capital website, those two indexes
are very similar.)

And of course each ETF's advisor has its own sampling strategy. Still
-- 6.57% of AGG's income is from US govt obligations while 26.57% of
BND's is from US govt obligations.

However, AGG lists Treasuries holdings of 35.62% vs. BND's 43.1% which
isn't that big a difference, so why the big difference in US govt
income percentages? Is it just sampling differences, with Vanguard
weighting higher-coupon Treasuries more in their scheme?
I believe you're confusing Treasury and Government. "Treasury" in the
traditional sense doesn't even include all Treasury obligations (it
excludes TIPs), let along all government agency obligations. Rather, it
includes only nominal rate Treasury paper.

M* reports BND's breakdown (12/31) as 35.65% Treasuries
(0% TIPs, 4.15% US Agency, 1.64% Non-US Government, and 1.95% Other
Government Related - for a total of 43.38%).

Vanguard reports BND's breakdown (1/31) as 43.1% Treasury/Agency.
 
R

Rich Carreiro

Mark Freeland said:
I believe you're confusing Treasury and Government. "Treasury" in the
traditional sense doesn't even include all Treasury obligations (it
excludes TIPs), let along all government agency obligations. Rather,
it includes only nominal rate Treasury paper.

M* reports BND's breakdown (12/31) as 35.65% Treasuries
(0% TIPs, 4.15% US Agency, 1.64% Non-US Government, and 1.95% Other
Government Related - for a total of 43.38%).

Vanguard reports BND's breakdown (1/31) as 43.1% Treasury/Agency.
That's exactly my point/question, though.

Both funds (on the funds' own websites) report two things related to
US obligations.

One thing they report is the percentage of 1099-DIV box 1a dividends
that is from US obligations (such amount is then excluded from state
taxable income).

The other thing they report is the percentage of the fund's assets
that are invested in US obligations. Such amounts are exempt from
state intangibles taxes (for those states that have them) and also
some states only exempt US obligation income from tax if the fund
invests at least 50% of its assets in US obligations.

AGG's (iShares's) website says that 6.57% of AGG's income
is from US obligations and 35.62% of its assets are invested
in US obligations.

BND's (Vanguard's) website says that 26.57% of BND's income
is from US obligations and 43.1% of its assets are invested
in US obligations.

I assume (perhaps incorrectly) that the reported income from US
obligations is the income from those instruments that are reported as
being US obligations the fund invested in. So how is it the funds
have similar percentages invested in US obligations but have very
different percentages of their income from US obligations?

(I can think of one contribution -- if one fund has a lot more
short-term cap gains. Those will be included in Box 1a dividends but
obviously are not income from US obligations. I believe AGG's STCGD
were indeed somewhat higher than BND's, but it's not enough to explain
the difference.)
 
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M

Mark Freeland

AGG's (iShares's) website says that 6.57% of AGG's income
is from US obligations and 35.62% of its assets are invested
in US obligations.

BND's (Vanguard's) website says that 26.57% of BND's income
is from US obligations and 43.1% of its assets are invested
in US obligations.

I assume (perhaps incorrectly) that the reported income from US
obligations is the income from those instruments that are reported as
being US obligations the fund invested in. So how is it the funds
have similar percentages invested in US obligations but have very
different percentages of their income from US obligations?

(I can think of one contribution -- if one fund has a lot more
short-term cap gains. Those will be included in Box 1a dividends but
obviously are not income from US obligations. I believe AGG's STCGD
were indeed somewhat higher than BND's, but it's not enough to explain
the difference.)
Initially I thought that the iShare's error(?) in excluding
non-Treasuries government obligations could explain the difference.
That is, since Treasuries yield close to nothing (well, 2% for 10
years), that the other government obligation investments could be
swamping the total return. So that extra 8% of the portfolio
(non-Treasury gov obligations) could actually account for 20% of the
total portfolio's return.

But iShare's tax questions seem to run deeper. We can take
classification issues out of the equation by looking at IEF - iShare's
7-10 year Treasuries ETF. This is 99% Treasuries (1% cash, per M*). No
ambiguities here. No short term gains (box 6), unlike AGG (25c/share
box 6 short term gain, or about 7% of total dividends). Yet barely half
(52%) of income is from US obligations (box 12).

Doesn't solve the puzzle, but makes the question simpler.

Another (wrong) guess I had was that iShares was using derivatives.
(They don't seem to be.) That could achieve the same tracking
performance, but with different tax impact. See, e.g. this 2008 paper:
"Present Law and Analysis Relating to the Tax Treatment of Derivatives"
(House Ways an Means Committee hearing)
http://www.jct.gov/publications.html?func=startdown&id=1319

On p. 14 (pdf p. 16): "In sum, despite the economic equivalence of the
returns that can be synthesized with the aid of various combinations of
derivatives, current law does not necessarily treat economically
equivalent returns in the same manner."

For IEF at least, the holdings themselves are weird. The latest
semi-anual statement shows 99% in Treasuries, 31% in MMFs, and -30% in
"other assets less liabilities".
http://us.ishares.com/content/stream.jsp?url=/content/en_us/repository/resource/semi_annual_report/is_sar_21.pdf
There's a similar "warp" in AGG - 99% in bonds, 20% in MMFs, -19% in
"other assets less liabilities".
http://us.ishares.com/content/stream.jsp?url=/content/en_us/repository/resource/semi_annual_report/is_sar_23.pdf&mimeType=application/pdf

As a reference point, BND had 99% in bonds, 5% in MMFs, and -4% in
"other assets less liabilities". Difference doesn't seem to be enough
to account for the huge disparity between BND and AGG government income
percentages though.

Don't know the answer, but it's an interesting puzzle.
 

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