A solid choice for short-term global bond exposure

This Bronze-rated DFA fund is useful for fixed-income investors in multiple ways.

Achilleas Taxildaris 20 September, 2016 | 5:00PM
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 DFA Five-Year Global Fixed Income offers investors a global, conservative portfolio supported by an established management team and DFA’s culture of academic rigour. For these reasons, it earns a Morningstar Analyst Rating of Bronze.

With a portfolio that is invested in more than a dozen countries, the fund is found within the Global Fixed-Income Morningstar Category. However, a unique process and conservative holding requirements mean it is a bit of a misfit in this more freewheeling global fixed-income category, and makes comparisons to short-term fixed-income funds relevant and sometimes necessary.

The maturity of the bonds within the fund is capped at five years. 40% of the fund was in bonds with four- to five-year maturities and 37% matured in three to four years. The remaining percentage was in bonds maturing in one to three years, an exposure that was increased from low single digits 12 months prior to 22.5%. When the curve is flat or inverted (downward sloping) the fund will move to the short end, since the yield is the same as if the fund had a longer maturity. This means the fund would have a return profile similar to riskier, longer-dated bonds. On the other hand, when the curve is normalized or steep (upward sloping) the fund will invest in longer-dated bonds to capture the increase in yield that is compensation for taking on more interest-rate risk. Therefore, it is useful to think of the fund as operating on a sliding scale; it can position itself from less than one year up to five years in maturity.

According to DFA’s research, bond returns are driven by term risk and credit risk. This fund takes credit risk off the table by investing in bonds rated AA or above, so the returns are driven by how much term risk the fund takes on--in other words, where it is positioned on the yield curve. The trading desk can be flexible in terms of when to buy and sell holdings, which is one of the characteristics that distinguish the firm. The team believes this allows them to find the best deals before transacting.

The fund can invest in Treasuries, agencies, corporates, supranational debt, and global corporates and sovereigns. Individual industries are capped at 25% of the portfolio, and individual issuers are capped at 5% with the exception of the Canadian government, which has no limit. Roughly 60% of the portfolio was in corporate bonds as of the end of June 2016, while the remainder of the portfolio was invested in agency bonds, sovereign debt, and bonds issued by supranational organizations.

The fund is extremely well diversified among countries, as of June 2016. The United States remains the largest at roughly 30%, followed by Canada (15.1%), Australia (8.5%), and Germany (6.7%). Japan, Sweden, and New Zealand together make up roughly 15% of the portfolio. The fund is completely hedged to the Canadian dollar, which limits currency risk.

Because the fund is much more conservative than the average Global Fixed-Income Category peer, it is useful to compare it with other categories to get a broader picture of its performance. This is especially true regarding the fund’s ability to shift its maturity from five years to less than one year, as well as its policy of hedging all currency exposure to the Canadian dollar, making it valid to compare the fund to the Canadian short-term fixed income category. It performs well in both cases, consistently beating the short-term category average over the long term but with more volatility. Despite its higher standard deviation of returns, its risk-adjusted returns rank in the top quartile among peers in both categories.

The fund scores a similar risk-adjusted rank among its global fixed-income peers, although it does so with lower absolute returns and volatility. From November 2003 through June 2016, the fund’s F series returned 3.8% annualized with a standard deviation of 2.1, which is lower than its global fixed-income peers. Its relatively muted volatility, partly due to the lack of non-Canadian dollar currency risk, has given global fixed-income investors a smooth ride. Since its inception, the fund has had only one negative year, losing less than 0.1% in 2013. Due to this solid but not stellar return history, the fund earns a Neutral Performance rating.

Because of its unique process, the fund can fill a variety of jobs in an investor’s portfolio. It can offer a conservative, high-quality global bond exposure to offset the risk of an equity-heavy portfolio, or it can be used to reduce credit and interest-rate risk alongside an aggressive bond allocation.

Dimensional Fund Advisors is a good steward, as all of its strategies are grounded in empirical research and an unwavering belief in market efficiency. The firm attempts to profit from the types of risk that the market compensates with simple screens that emphasize securities with characteristics that historically have been associated with higher expected returns. This disciplined approach has served investors well.

The fund's 1.47% management expense ratio is competitive within the commission-based peers. This fee is expensive in the short-term, but lower than the Global Fixed-Income Category median of 1.82% in the same distribution channel, landing comfortably in the cheapest quintile.

The fund's F series has a management expense ratio of only 0.35% and it’s the cheapest available option in the fee-based distribution channel for the Global Fixed-Income Category. This price tag would also be one of the cheapest options in the Short-Term Fixed-Income Category.

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Achilleas Taxildaris

Achilleas Taxildaris  Achilleas Taxildaris is analyst for Manager Research and focuses on active strategies.

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