Investment Primer: The Taxable – Fixed Income Composite

Share

What, Why, and How of Taxable Fixed Income

The Taxable Fixed Income composite includes funds that are the bedrock of the bond market, investing in a wide array of debt instruments where the income generated is subject to federal taxes. The “why” is threefold: to generate a predictable stream of income, to preserve capital, and to provide diversification from the volatility of equity markets.

The “how” is achieved by holding portfolios of various debt types. These can range from the safest U.S. Treasury bonds to higher-yielding corporate “junk” bonds. Funds in this composite can be passive Beta strategies that track a broad bond index (like the Bloomberg U.S. Aggregate) or actively managed Factor or Tactical funds where a manager makes decisions on credit quality, interest rate sensitivity, and sector allocation.

Deconstructing the Fixed Income Market

To effectively use fixed income funds, it’s essential to understand the two primary risks that drive their performance: credit risk and interest rate risk (duration), as well as the different debt types available.

Debt Types

The taxable bond market is incredibly diverse, with each segment offering a different risk and return profile. The main categories include:

  • Government: These are bonds issued by sovereign governments. U.S. Treasury bonds are considered to have no credit risk. This category also includes agency bonds (issued by government-sponsored entities like Fannie Mae) and inflation-protected securities (TIPS), whose principal adjusts with inflation.
  • Corporate: These are bonds issued by public companies to fund their operations. They are categorized by their credit quality, from high-quality “Investment Grade” to lower-quality, higher-yielding “High Yield” (or “junk”) bonds.
  • Bank Loans (Senior Loans): These are loans made to corporations, typically with below-investment-grade credit ratings. A key feature is that their interest rates are not fixed but “float” based on a short-term reference rate, giving them very low sensitivity to interest rate changes. This category also includes Collateralized Loan Obligations (CLOs), which are complex securities backed by pools of these loans.
  • Securitized Debt: These are bonds backed by pools of other assets. The most common are Mortgage-Backed Securities (MBS), which are backed by pools of residential mortgages. This category also includes Asset-Backed Securities (ABS), backed by assets like auto loans or credit card receivables.
  • International & Emerging Market Debt: These are bonds issued by governments or corporations outside of the U.S. They can be denominated in U.S. dollars (removing direct currency risk) or in the issuer’s local currency (adding currency risk as a factor).

The Two Key Risks

  • Credit Risk: This is the risk that the bond issuer will be unable to make its interest payments or repay the principal amount at maturity—in other words, the risk of default. U.S. Treasury bonds are considered to have zero credit risk. For all other bonds, credit rating agencies (like S&P and Moody’s) assign a rating to indicate their creditworthiness.
    • Investment Grade: Bonds with high credit ratings (BBB- or higher). These are considered to have a low risk of default.
    • High Yield (“Junk”): Bonds with lower credit ratings (BB+ or lower). They offer higher yields to compensate investors for the higher risk of default.
  • Interest Rate Risk (Duration): This is the risk that a bond’s price will fall when interest rates rise. Duration is a metric that measures a bond’s price sensitivity to a 1% change in interest rates. A bond with a duration of 5 years would be expected to lose approximately 5% of its value if interest rates rise by 1%.
    • Ultrashort & Short Duration: Funds with very low sensitivity to interest rate changes, often used as cash alternatives.
    • Intermediate Duration: Funds with a moderate level of interest rate risk, often used as core bond holdings.
    • Long Duration: Funds with high sensitivity to interest rate changes, used to express a view on rates or for long-term liability matching.

A Practical Guide to Locating Funds in the ETF Action Database

The Taxable Fixed Income universe is the largest and most diverse in the fund world. ETF Action’s classification system is designed to help users precisely navigate this space by filtering on the key characteristics discussed above.

Foundational Screening: Building the Initial Universe

  • Step 1: Select the Database. Navigate to the ETF, Mutual Fund, or other desired database.
  • Step 2: Filter by Asset Class. Select Asset Class = Fixed Income.
  • Step 3: Filter by Composite. Select Composite = FI: Taxable.
  • Step 4: Filter by Category. This is the primary filter for Debt Type (e.g., Fixed Income: Taxable – Corporate, Fixed Income: Taxable – Government Short, Fixed Income: Taxable – High Yield).
  • Step 5: Filter by Selection & Implementation. These are the key filters for risk. The Selection filter targets Credit Risk (e.g., Credit: Investment Grade, Credit: High Yield). The Implementation filter targets Duration (e.g., Duration: Short, Duration: Intermediate).

Advanced Filtering: Refining Your Peer Group

  • Segment & Group: Use these filters for more granular searches within a category. For example, after selecting the Fixed Income: Taxable – Government… category, you can use the Segment filter to isolate Treasury or Agency bonds, and the Group filter to find Inflation-Protected securities.
  • Brand (Issuer), AUM, Expense Ratio, Liquidity: Use these standard filters to narrow the list to viable candidates.

Section 4: A Framework for Evaluating Taxable Fixed Income Funds

A thorough evaluation of a fixed income fund requires going beyond its name and stated yield to understand its underlying risk exposures. This is where ETF Action’s institutional-grade look-through datasets are essential.

Risk/Return Analysis: The Importance of Benchmarks

The foundational step is to analyze a fund’s historical risk and return profile against an appropriate benchmark. ETF Action assigns a Beta Tracker to each category (e.g., AGG for Core, JNK for High Yield) to provide a relevant peer for comparison. Key metrics from the Risk & Return profile are crucial:

  • Total Return: How has the fund performed over various time periods compared to its benchmark?
  • Standard Deviation (Volatility): Was the fund more or less volatile than its benchmark?
  • Sharpe Ratio: Did the fund provide better risk-adjusted returns?

4.2 Quantitative Analysis: The Power of Look-Through Analytics

A fund’s name tells you its category, but its holdings reveal its true risk profile. Look-through analysis is critical for fixed income.

  • Credit Quality Breakdown: While a fund’s credit classification (e.g., Investment Grade, High Yield) directs you to its targeted rating bucket (AAA, AA… CCC, etc.), the Option-Adjusted Spread (OAS) is the market’s way of assessing credit risk in real-time. OAS can vary widely even for funds within the same rating category, and it provides a truer picture of the risk investors are being compensated for.
  • Duration & Yield Curve Positioning: What is the fund’s precise effective duration? How are its holdings positioned along the yield curve (e.g., is it concentrated in 5-year bonds, or does it have a “barbell” strategy with holdings in both 2-year and 10-year bonds)?
  • Sector & Issuer Concentration: For multi-sector funds, what is the breakdown between government, corporate, and securitized debt? Is the fund overly exposed to a single corporate issuer?

While a detailed, manual look-through analysis provides the deepest insights, it can be time-intensive. ETF Action’s derived analytics are designed to simplify this process by providing a completely objective, rules-based framework. The classifications, such as the Fixed Income – Credit Assignment (Investment Grade, High Yield) or Fixed Income – Duration Assignment (Short, Intermediate, Long), are rules-based labels that place a fund into a specific bucket. The derived analytics, like the Fixed Income – Credit Quality Tilt Rating or the Fixed Income – YTM Tilt Rating, offer a more nuanced view. They quantify the intensity of a fund’s characteristics on a numeric scale relative to a broad market benchmark. This dual system provides a powerful framework to more efficiently search for funds and conduct an initial evaluation.

4.3 Qualitative Analysis: Evaluating the Strategy

  • For Passive Funds (Beta): The key is to understand the index methodology. How does the index select and weight bonds? A market-cap (debt-weighted) index will be most exposed to the largest issuers of debt.
  • For Active Funds (Factor, Tactical): The focus is on the manager’s process. How do they make decisions about duration, credit, and sector allocation? The qualitative review should confirm that the manager’s philosophy is reflected in the portfolio’s look-through characteristics.

Ready to Put This Knowledge to Work?

The best insights come from the best tools. Join ETF Action to screen, compare, and analyze thousands of ETFs with our premium suite of resources for serious investors.