CGBL: An All-Weather ETF To Balance Your Portfolio (NYSEARCA:CGBL) #NewsETFs

The Capital Group Core Balanced ETF (NYSEARCA:CGBL) is a non-diversified fund that focuses on giving investors an equities-heavy mix of fixed-income holdings and stocks. About a third of the ETF’s roughly $855 million AUM is invested in Capital Group’s own fixed-income ETFs, specifically the Capital Group Core Plus Income ETF (CGCP) and the Capital Group Core Bond ETF (CGCB). This component usually varies from about 25% of the fund’s holdings to roughly 33%. Between 50% and 70% of the AUM goes towards equity, and the rest is held in cash and equivalents. The asset mix looked like this at the end of last month.

CGBL has an attractive expense ratio of 0.33%, with a daily share liquidity of just under 300k shares and a very low turnover of 3% in the last year, which I really like because it tells me the strategy is well-thought-out and carefully implemented by the fund’s portfolio managers. The fund is advised by Capital Research and Management Company.

An Equities-Centric Fund – Will it Work in the Current Market Climate?

That’s usually my first question when I look at the composition of such ‘balanced’ funds, particularly since interest rate dynamics could soon change and the market is quite volatile right now – a little calmer than it’s been in the past two months, and I discuss that further down the article.

The classic 60-40 structure is still maintained to a degree, and right now, the skew is toward mortgage-backed securities, corporate debt, treasuries, and other fixed-income vehicles.

That would make sense in this environment because interest rates have been at these elevated levels for the better part of two years now, heading north of the 3% to 3.25% target rate since September 2022 and holding firm at 5.25% to 5.5% for more than a year. Still, the 32% fixed-income portion might not be appealing enough to many fixed-income investors looking at generating retirement income, particularly in what could soon be a declining interest rate environment.

So, the question is, does this mix still make sense when rates are getting ready to drop, or should you invest in an ETF that focuses solely on equities or on fixed-income assets alone?

My take is that you need to look at the quality of a fund’s holdings, not just the ratio/mix, which doesn’t always tell the whole story.

High-quality Equities with High-quality Fixed Income Assets

Quality is very relative, of course, but it helps to look at the holdings on each side of this equation and make a reasonably accurate assessment of how each might perform in a falling interest rate environment.

Let’s begin with the fixed-income side.

As of August 31, 2024, the ETF’s fixed income assets had an effective duration of 6 years, with a yield to the worst average of 5.3% and a coupon average of 5.5%. This indicates a moderate sensitivity to interest rate changes, so total asset value should marginally increase if and when Fed funds rates decline. Most investors would consider that to be of medium quality. A lower effective duration would be ideal, which means this ETF may not be suitable for fixed-income investors looking for higher distributions rather than greater price appreciation. If you’re after more predictable income, a pure play on long-dated bonds might be the way to go. The 30-day SEC yield for this ETF is close to 3%, but the ETF’s distribution yield is only about 1.24%, with a forward payout of 38 cents against a current market price of $30.60 as I write this.

The equity component, however, is where much of the capital appreciation will kick in, so let’s look at that side in more detail.

Over the past year since its inception (9/26/2023), the ETF has appreciated by about 22%. That said, if you look at YTD total return, the ETF doesn’t seem to have performed anywhere near what the broader market has returned in that time frame.

So, does that mean the quality of its equity holdings is sub-par? Not necessarily. One thing you’ll notice is that, even though the fund’s investments are nearly 15% weighted to the technology sector, we also see heavy allocations to what are largely defensive sectors such as healthcare, consumer staples, and materials, as well as some high-quality stocks in energy and real estate. A quick look at a few of these follows.

Key Defensive Holdings

Eli Lilly (LLY)

Aside from the massively popular tirzepatide, sold as Zepbound for weight loss and Mounjaro for T2DM, or type 2 diabetes mellitus, LLY has a strong late-stage pipeline for cardiometabolic health, immunology, oncology, and neuroscience indications. Among the major conditions these molecules are targeting are OSA or obstructive sleep apnea (global prevalence estimated at 936 million individuals), diabetes (200 million individuals estimated by 2040, of which 90% is T2DM), obesity (from ~800 million individuals in 2020 to 1.53 billion over the next decade), atopic dermatitis (~10% of the U.S. population or 31.6 million individuals), multiple sclerosis (~1.8 million individuals), Alzheimer’s (~6.9 million individuals in the U.S. alone), Parkinson’s (~8.5 million individuals as of 2019), etc.

The massive addressable market for these indicators is a testament to LLY’s potential to help treat or manage key lifestyle-impairing as well as life-threatening conditions. As such, with many of these in late-stage clinical, the potential for growth is significant.

Since the last quarter (ended June 30), CGBL has increased its LLY holding from 14.5k shares to 20.2k shares (as of August 31), presumably taking advantage of the temporary decline in LLY stock, which dropped during the broad-market sell-off that began in the second week of July – from the then-ATH of around $950 to a low of around $770 in early August. The stock has bounced back since and currently trades at $935 as I write this. September performance has been a little disappointing thus far, but YoY growth hasn’t let up, and with a 32% YoY growth rate in the TTM period and +25% projected for the current fiscal year, my opinion is that LLY is only $170 million shy of becoming a trillion-dollar company.

Though the current valuation seems high at 21 times revenues, analyst projections for revenue growth are strong and should bring that multiple down to under 18x by the end of FY 2024 and even further down to 14.5x at the end of FY 2025.

To digress a little, I think a stock split right about now would be perfect because it will bring even more liquidity at a time when investors are actively looking for opportunities to preserve their capital. Nothing on the rumor front there, but you never know. The last split was a 2-for-1 about 27 years ago, in 1997, but I’d like to see a higher ratio if the company decides to do another split once the shares hit $1000, which I don’t think is too far away.

UnitedHealth Group (UNH)

CGBL has also increased its stake in UNH since the June quarter, up from 22k shares to the current (Aug 31) 26k shares. UNH’s stellar performance is marked by a 16-quarter streak of beating estimates on both lines, and the stock has appreciated more than 22% in the last year.

From a valuation perspective, UNH gets moderate Quant grades for its earnings multiples, but its price to forward sales multiple of <1.4x is at a 65% discount to the sector median. With analysts predicting increasingly stronger double-digit sales growth over the next five years or so, this is definitely a good holding for CGBL.

Philip Morris International (PM)

Going from healthcare to tobacco might seem like a stark contrast, but this mix is excellent for CGBL’s portfolio. PM is growing its revenues close to double-digit percentages, which are double its 5Y average of 4%. It is also extremely profitable, with a TTM operating margin that’s 3.5x (+250%) the median for the consumer staples sector.

The cherry on top is the +4% forward yield, and despite its lofty revenue-based multiple above 5x and recent softness in momentum, the stock has returned an impressive 39% in the last year, with dividends reinvested.

Although earnings growth slowed down to nearly 5% in the second quarter, forward projections are much stronger, and we could see double-digit EPS growth over the next few quarters.

CGBL seems to have doubled down on PM in the last month, with the holding increasing from 82k shares to nearly 130k shares at the last report at the end of August. A good move, in my opinion, particularly as the company’s earnings have strong forward projections and are likely to help its earnings-based multiples re-rate higher over the next several quarters. Even if valuation holds steady at the 20.5x level for adjusted earnings (TTM basis), if PM is able to achieve $7.00 in EPS by the end of FY 2025, that translates to a share price of at least $143 for a potential 15% upside in the next year and a half – not a bad gain when the market is fully aware that a recession might still come.

Should You Invest in CGBL Now?

Of course, your investment preferences should always dictate where your money goes, but it’s often useful to keep assessing alternative options – either to safeguard your capital during volatile times or enhance your returns in stable and bull markets. From that perspective, it’s certainly prudent to ensure that the bulk of your investments are protected from risk without having to sacrifice upside potential.

One might argue that expected volatility is now down to the under 20 range for the “Fear Index”, the S&P VIX Index (VIX), but this might well be the calm before the storm. With the FOMC meeting being one of the most highly anticipated news stories in the week ahead, things may well turn ugly again, the way they were in early August and, to a lesser degree, at the start of September.

Though still elevated, the market seems to have calmed down quite a bit after the frenzy of the past couple of months. Still, it remains unpredictable, which makes a case for investments like CGBL, where your bond holdings are expected to do moderately well in the event of a rate cut and still give you a reasonable yield, and your equities portion are likely to hold steady or even beat the market if we see stronger signs of an imminent recession – typically a cue for defensive stocks to do their magic.

As I noted in my articles on Microsoft Corporation (MSFT) in June and Taiwan Semiconductor Manufacturing Company (TSM) a couple of days ago, even if you’re investing in a risky and highly volatile sector like technology, which is a 15% component of CGBL, making the right picks makes all the difference between sleeping well and tossing and turning all night.

Here’s what I said in June in my MSFT article titled, Appreciating Microsoft’s ‘Trojan Horse’ Strategy For Success:

The risk here is as minimal as it gets. Unless there’s a major pivot away from AI in the far future, which I see as an extremely remote possibility, Microsoft’s recurring revenues and the growth they’re currently experiencing that keeps adding to those recurring figures mitigate nearly all the risk of owning MSFT stock.

I still hold that view about Microsoft, and about technology stocks that have long runways for growth, such as TSM. I invite you to read those articles.

Of course, I’m also very bullish on runaway successes like Nvidia Corp. (NVDA), which I reiterated this month in Nvidia Q2 Offers Several Clues To Sustainable Growth Ahead, but I do understand that many investors that are drawn to these high-growth stocks tend to jump ship at the slightest sign of trouble, as they did when NVDA’s forward guidance was perceived as being weak, thereby prompting a sell-off.

As you can see, the bulls took over again shortly after, pushing the stock back to the $119 level it was trading at before earnings were announced. Nevertheless, a holding like NVDA would make CGBL a lot more unpredictable, particularly if it had a high weighting.

The point I’m trying to make is that ETFs like CGBL need closer study. We can’t just look at one angle, such as price momentum or dividend yield or holdings composition, and come to an investment decision. As I’ve done with my thesis for this ETF, you need to look at various aspects, not only historical ones but also by factoring in forward expectations. And what this analysis tells me is that this would be a good fund to have in your portfolio, for all the reasons I’ve outlined above.

To summarize, the bond component looks like it can counteract rate cuts, the equity portion will very likely buck trends in the event of a hard landing once the rate cuts are initiated, and historical performance should continue as long as the economy in the United States remains resilient, which it has shown to be. To me, that points to a clear Buy.