Schwab Intelligent Portfolios Guide to Asset Classes & ETFs

Stocks

• U.S. Large Company Stocks
• U.S. Large Company Stocks–Fundamental
• U.S. Small Company Stocks
• U.S. Small Company Stocks–Fundamental
• International Developed Large Company Stocks
• International Developed Large Company Stocks–Fundamental
• International Developed Small Company Stocks
• International Developed Small Company Stocks–Fundamental
• International Emerging Markets Stocks
• International Emerging Markets Stocks–Fundamental
• U.S. Exchange-Traded REITs
• International Exchange-Traded REITs
• U.S. High Dividend Stocks
• International High Dividend Stocks

Fixed Income

• U.S. Treasuries
• U.S. Investment Grade Corporate Bonds
• U.S. Securitized Bonds
• U.S.  Inflation Protected Bonds
• U.S. Corporate High Yield Bonds
• International Developed Country Bonds
• International Emerging Markets Bonds
• Preferred Securities
• Bank Loans
• Investment Grade Municipal Bonds
• Investment Grade California Municipal Bonds 

Commodities

• Gold and Other Precious Metals

Cash

• FDIC-insured Cash

• What is it?
  U.S. large company stocks—fundamental are investments of larger U.S. companies that are included in fundamental indexes, which screen and weight companies based on fundamental factors such as sales, cash flow and dividends. Most traditional stock indexes are constructed based on market-cap (e.g., S&P 500^®, Russell 2000^®, etc.), where companies with the largest market capitalizations have the largest weights. Including allocations to fundamentally weighted indexes adds diversification within a portfolio and may improve risk-adjusted returns over time. Due to their differences in construction, fundamentally weighted indexes tend to behave differently than market cap-weighted indexes in different market environments while retaining benefits of traditional indexing such as transparency and relatively low-cost implementation. 
• What role does it play in a portfolio?
  Investments in fundamentally weighted ETFs and traditional market-cap weighted ETFs can be used as a complement to each other because they differ in their performance under various market environments. The end result is a portfolio that we believe will result in better risk-adjusted results over time.
• When does it perform well?
  Based on research conducted by Research Affiliates, LLC, FTSE Russell, and Schwab Center for Financial Research among others, fundamental index strategies have outperformed market-cap indexes over longer time periods. This is partly attributable to the fact that the fundamental strategies break the link of assigning a weighting with the price of the stock. A market-cap index provides the largest weighting to the largest companies regardless of valuation. As a result, market-cap indexes can be described as "overweighting over priced stocks and underweighting undervalued stocks."³ Since fundamental index strategies tend to overweight companies that appear cheap based on various financial metrics, they tend to outperform in environments that reward such "cheap" aka value stocks. As for their absolute level of performance, fundamental strategies are affected in much the same way and by the same factors as U.S. large company stocks.
• When does it perform poorly?
  Fundamental index strategies may lag market-cap indexes in "boom" or "momentum" periods or when the biggest companies (as measured by market capitalization) dramatically outperform the smaller companies in an index.
• ETF Selection

• Why these ETFs were selected: Based on Morningstar classifications, two ETF providers offered ETFs in this category at the time of ETF selection. While there are many indexing approaches that incorporate various fundamental factors, classifications for fundamental strategies within Schwab Intelligent Portfolios are based on Morningstar's classification for index selection and index weighting (among other data points). From among the eligible funds in this asset class, FNDX had the lowest operating expense ratio at the time of ETF selection while meeting all other criteria. Both FNDX and PRF had sizable assets under management and have historically traded with relatively narrow bid-ask spreads.

• Why other ETFs were not selected: The category consists of just two ETFs.

• What is it?
  U.S. small company stocks—or "small caps"—are investments in the equity of smaller U.S. companies, generally those that represent the bottom 10% of the market by cumulative market capitalization. Small company stocks may provide greater potential for growth than large company stocks. However, they are riskier because their size makes them more vulnerable to economic shocks, inexperienced management, competition and financial instability.
• What role does it play in a portfolio?
  The U.S. small company stocks offer higher growth potential than many other asset classes because of the potential for such companies to grow rapidly. Small cap stocks have higher expected long-term returns relative to other asset classes to compensate for the higher risk associated with them. 
• When does it perform well?
  U.S. small company stocks generally perform well when the economy is expanding or investors expect such expansion to occur. Small company stocks tend to be more closely tied to the strength of the U.S. economy than large company stocks because they typically generate most of their revenue within the U.S. while large multinational companies often generate a substantial portion of revenue in multiple geographies around the world. Valuation matters as well. When prices are low relative to, for example, earnings, subsequent price performance is more likely to be strong.
• When does it perform poorly?
  During extreme equity market or economic stress, these stocks tend to perform poorly. When prices are high relative to earnings, price performance can suffer.
• ETF Selection

• What is it?
  U.S. small company stocks—fundamental are investments in the equity of smaller U.S. companies that are included in fundamental indexes, which screen and weight companies based on fundamental factors such as sales, cash flow and dividends. Most traditional stock indexes are constructed based on market-cap (e.g., S&P 500^®, Russell 2000^®, etc.), where companies with the largest market capitalizations have the largest weights. Including allocations to fundamentally weighted indexes adds diversification within a portfolio and may improve risk-adjusted returns over time. Due to their differences in construction, fundamentally weighted indexes tend to behave differently than market cap-weighted indexes in different market environments while retaining benefits of traditional indexing such as transparency and relatively low-cost implementation. 
• What role does it play in a portfolio?
  Investments in fundamentally weighted ETFs and traditional market-cap weighted ETFs can be used as a complement to each other because they differ in their performance under various market environments. The end result is a portfolio that we believe will result in better risk-adjusted results over time.
• When does it perform well?
  Based on research conducted by Research Affiliates, LLC, FTSE Russell, and Schwab Center for Financial Research among others, fundamental index strategies have outperformed market-cap indexes over longer time periods. This is partly attributable to the fact that the fundamental strategies break the link of assigning a weighting with the price of the stock. A market-cap index provides the largest weighting to the largest companies regardless of valuation. As a result, market-cap indexes can be described as "overweighting over priced stocks and underweighting undervalued stocks."⁴ Since fundamental index strategies tend to overweight companies that appear cheap based on various financial metrics, they tend to outperform in environments that reward such "cheap" aka value stocks.  As for their absolute level of performance, fundamental strategies are affected in much the same way and by the same factors as U.S. small company stocks.
• When does it perform poorly?
  Fundamental strategies may lag market-cap indexes in "boom" or "momentum" periods or when the biggest companies (as measured by market capitalization) dramatically outperform the smaller companies in an index.
• ETF Selection

• Why these ETFs were selected: Based on Morningstar classifications, two ETF providers offered ETFs in this category at the time of ETF selection. While there are many indexing approaches that incorporate various fundamental factors, classifications for fundamental strategies within Schwab Intelligent Portfolios are based on Morningstar's classifications for index selection and index weighting (among other data points). At the time of ETF selection, there were only two ETFs classified within this category. Both FNDA and PRFZ had over $2 billion in assets under management and have historically traded with relatively narrow bid-ask spreads. FNDA was selected as the primary ETF because it had the lowest expense ratio at the time of ETF selection. PRFZ, which is slightly more expensive, was selected as the secondary. 

• Why other ETFs were not selected: The category consists of just two ETFs.

• What is it?
  International developed large company stocks are investments in the equity of larger foreign companies that have high market capitalizations and are domiciled in countries with mature economies. The stock markets in these developed countries benefit from strong investor protections, corporate governance and legal infrastructure. Investing in these stocks involves additional risks, which include differences in financial accounting standards, currency fluctuations, geopolitical risk, foreign taxes and regulations, and the potential for illiquid markets.
• What role does it play in a portfolio?
  While U.S. companies can have vast international operations and exposure, investing solely in U.S. stocks means excluding nearly three-fourths of the global economy and over half of the world's stock market value. International developed large company stocks provide some of the same benefits as U.S. large-company stocks – growth potential and more stable financial results than smaller foreign companies – but provide diversification benefits due to their exposure to non-U.S. markets. In addition, investing in companies located overseas offers the potential to benefit from currency diversification—foreign company returns are generally denominated in foreign currencies, so they provide some protection against a potential fall in the value of the U.S. dollar relative to those currencies.
• When does it perform well?
  This asset class tends to perform well when international developed countries are growing more rapidly than the U.S. and when their currencies are appreciating against the U.S. dollar. Valuation matters as well. When prices are low relative to, for example, earnings, subsequent price performance is more likely to be strong.
• When does it perform poorly?
  When the U.S. dollar is gaining against these currencies, this asset class tends to perform poorly relative to U.S. stocks. The relative performance can also be poor when non-U.S. economies are weakening or expected to weaken. When prices are high relative to earnings, price performance can suffer.
• ETF Selection

• What is it?
  International developed large company stocks – fundamental are investments in the equities of larger foreign companies that are included in fundamental indexes, which screen and weight companies based on fundamental factors such as sales, cash flow and dividends. Most traditional stock indexes are constructed based on market-cap (e.g., S&P 500^®, Russell 2000^®, etc.), where companies with the largest market capitalizations have the largest weights. Including allocations to fundamentally weighted indexes adds diversification within a portfolio and may improve risk-adjusted returns over time. Due to their differences in construction, fundamentally weighted indexes tend to behave differently than market cap-weighted indexes in different market environments while retaining benefits of traditional indexing such as transparency and relatively low-cost implementation. 
• What role does it play in a portfolio?
  Investments in fundamentally weighted ETFs and traditional market-cap weighted ETFs can be used as complements in an investment portfolio because they tend to perform differently in various market environments. Including both market cap-weighted and fundamentally weighted ETFs in a portfolio can enhance diversification and potentially improve risk-adjusted results over time.
• When does it perform well?
  Based on research conducted by Research Affiliates, LLC, FTSE Russell, Schwab Center for Financial Research and others, fundamental index strategies have outperformed market-cap indexes over longer time periods. This is partly attributable to the fact that fundamental strategies break the link of assigning a weighting with the price of the stock. A market-cap index provides the largest weighting to the largest companies by market cap regardless of valuation. As a result, market-cap indexes can be described as "overweighting over priced stocks and underweighting undervalued stocks."⁵ Since fundamental index strategies tend to overweight companies that appear cheap based on various financial metrics, they tend to outperform in environments that reward such "cheap" aka value stocks. As for their absolute level of performance, fundamental strategies are affected in much the same way and by the same factors as other international developed large company stocks. 
• When does it perform poorly?
  Fundamental index strategies may lag market-cap indexes in "boom" or "momentum" periods or when the biggest companies (as measured by market capitalization) dramatically outperform the smaller companies in an index.
• ETF Selection

• Why these ETFs were selected: Based on Morningstar classifications, two ETF providers offered ETFs in this category at the time of ETF selection. While there are many indexing approaches that incorporate various fundamental factors, classifications for fundamental strategies within Schwab Intelligent Portfolios are based on Morningstar's classifications for index selection and index weighting (among other data points). Among the two ETFs in this category, FNDF was selected as the primary ETF because it had the lowest expense ratio at the time of ETF selection. PXF, which was slightly more expensive in terms of OER, was selected as the secondary ETF. Both FNDF and PXF had sizable assets under management and have historically traded with relatively narrow bid-ask spreads.

• Why other ETFs were not selected: The category consists of just two ETFs.

• What is it?
  International developed small company stocks are investments in the equity of smaller foreign companies that are domiciled in countries with mature economies and stock markets that benefit from strong investor protections, corporate governance and legal infrastructure. Investing in international developed small company stocks involves additional risks, which include differences in financial accounting standards, currency fluctuations, geopolitical risk, foreign taxes and regulations, and the potential for illiquid markets.
• What role does it play in a portfolio?
  Like U.S. small company stocks, these investments offer greater potential for growth than their large-cap counterparts. In addition, they provide diversification relative to U.S. markets because the revenues of these companies tend to be tightly tied to their home countries. By contrast, large multinational companies typically generate revenues in multiple geographies around the world.
• When does it perform well?
  International developed small company stocks typically perform well during the earlier stages of a global economic recovery. A strong foreign currency relative to the dollar also enhances the returns of international developed small company stocks. Valuation matters as well. When prices are low relative to earnings, for example, subsequent price performance is more likely to be strong.
• When does it perform poorly?
  A struggling global economy adversely impacts the performance of these stocks. When prices are high relative to earnings, price performance can suffer.
• ETF Selection

• Why these ETFs were selected: Finding low-cost exposure to international small company stocks can be challenging. Among the funds in this category, expense ratios ranged from 0.07% to 0.60%. Each of our selected ETFs had competitive expense ratios, more than $3 billion in AUM at the time of ETF selection and have historically traded with relatively narrow bid-ask spreads.

• Why other ETFs were not selected: iShares MSCI EAFE Small-Cap (SCZ) is the largest ETF in this category but had a significantly higher expense ratio at the time of ETF selection. SPDR^® S&P International Small Cap ETF (GWX) also has a higher expense ratio.

• What is it?
  International developed small company stocks - fundamental are investments in the equities of smaller foreign companies that are included in fundamental indexes, which screen and weight companies based on fundamental factors such as sales, cash flow and dividends. Most traditional stock indexes are constructed based on market-cap (e.g., S&P 500^®, Russell 2000^®, etc.), where companies with the largest market capitalizations have the largest weights. Including allocations to fundamentally weighted indexes adds diversification within a portfolio and may improve risk-adjusted returns over time. Due to their differences in construction, fundamentally weighted indexes tend to behave differently than market cap-weighted indexes in different market environments while retaining benefits of traditional indexing such as transparency and relatively low-cost implementation. 
• What role does it play in a portfolio?
  Investments in fundamentally weighted ETFs and traditional market-cap weighted ETFs can be used as complements in an investment portfolio because they tend to perform differently in various market environments. Including both market cap-weighted and fundamentally weighted ETFs in a portfolio can enhance diversification and potentially improve risk-adjusted results over time.
• When does it perform well?
  Based on research conducted by Research Affiliates, LLC, FTSE Russell, Schwab Center for Financial Research and others, fundamental index strategies have outperformed market-cap indexes over longer time periods. This is partly attributable to the fact that fundamental strategies break the link of assigning a weighting with the price of the stock. A market-cap index provides the largest weighting to the largest companies by market cap regardless of valuation. As a result, market-cap indexes can be described as "overweighting over priced stocks and underweighting undervalued stocks."⁶ Since fundamental index strategies tend to overweight companies that appear cheap based on various financial metrics, they tend to outperform in environments that reward such "cheap" aka value stocks. As for their absolute level of performance, fundamental strategies are affected in much the same way and by the same factors as other international developed small company stocks.
• When does it perform poorly?
  Fundamental index strategies may lag market-cap indexes in "boom" or "momentum" periods, or when the biggest companies (as measured by market capitalization) dramatically outperform the smaller companies in an index. 
• ETF Selection

• Why these ETFs were selected: Based on Morningstar classifications, two ETF providers offered ETFs in this category at the time of ETF selection. While there are many indexing approaches that incorporate various fundamental factors, classifications for fundamental strategies within Schwab Intelligent Portfolios are based on Morningstar's classifications for index selection and index weighting (among other data points). Among the two ETFs in the category, FNDC was selected as the primary ETF because it had the lowest expense ratio at the time of ETF selection and has historically exhibited slightly higher liquidity.

• Why other ETFs were not selected: The category consists of just two ETFs.

• What is it?
  Emerging market stocks are equity investments in foreign companies domiciled in countries with developing economies that have been experiencing rapid growth and industrialization. Emerging markets differ from their developed market counterparts in four main ways: (1) They have lower household incomes; (2) They are undergoing structural changes, such as modernization of infrastructure or moving from a dependence on agriculture to manufacturing; (3) Their economies are undergoing development and reform programs; (4) Their markets are less mature. Emerging markets are riskier than developed markets due to greater potential for political instability, currency fluctuations, an uncertain regulatory environment, volatility and higher investment costs.
• What role does it play in a portfolio?
  Emerging markets offer a unique combination of benefits: (1) Higher growth potential than developed markets, as corporate revenues have the potential to grow faster when economic growth is higher. (2) Diversification. By investing in emerging markets, diversification increases as emerging markets can perform differently than developed markets. 
• When does it perform well?
  Emerging market stocks generally perform well during periods of faster growth when commodities are trading at relatively high levels, local export markets are thriving due to a growing economy, and local governments implement policies more conducive to private sector growth. Valuation matters as well. When prices are low relative to earnings, for example, subsequent price performance is more likely to be strong.
• When does it perform poorly?
  Emerging market stocks typically struggle when the U.S. is in a recession or experiencing a slow-growth environment. Also, due to their relatively high dependence on commodity sales, they typically don't perform well when commodities are experiencing declining prices. Periods of high geopolitical risk are also harmful for emerging market stocks. When stock prices are high relative to earnings, price performance can suffer.
• ETF Selection

• What is it?
  International emerging market stocks—fundamental are investments in the equity of foreign companies that are based in countries experiencing rapid growth and industrialization, and are included in fundamental indexes, which screen and weight companies based on fundamental factors such as sales, cash flow and dividends. Most traditional stock indexes are constructed based on market-cap (e.g., S&P 500^®, Russell 2000^®, etc.), where companies with the largest market capitalizations have the largest weights. Including allocations to fundamentally weighted indexes adds diversification within a portfolio and may improve risk-adjusted returns over time. Due to their differences in construction, fundamentally weighted indexes tend to behave differently than market cap-weighted indexes in different market environments while retaining benefits of traditional indexing such as transparency and relatively low-cost implementation. 
• What role does it play in a portfolio?
  Investments in fundamentally weighted ETFs and traditional market-cap weighted ETFs can be used as complements in an investment portfolio because they tend to perform differently in various market environments. Including both market cap-weighted and fundamentally weighted ETFs in a portfolio can enhance diversification and potentially improve risk-adjusted results over time.
• When does it perform well?
  Based on research conducted by Research Affiliates, LLC, FTSE Russell, Schwab Center for Financial Research and others, fundamental index strategies have outperformed market-cap indexes over longer time periods. This is partly attributable to the fact that fundamental strategies break the link of assigning a weighting with the price of the stock. A market-cap index provides the largest weighting to the largest companies by market cap regardless of valuation. As a result, market-cap indexes can be described as "overweighting over priced stocks and underweighting undervalued stocks."⁷ Since fundamental index strategies tend to overweight companies that appear cheap based on various financial metrics, they tend to outperform in environments that reward such "cheap" aka value stocks. As for their absolute level of performance, fundamental strategies are affected in much the same way and by the same factors as other emerging market stocks.
• When does it perform poorly?
  Fundamental index strategies may lag market-cap indexes in "boom" or "momentum" periods or when the biggest companies (as measured by market capitalization) dramatically outperform the smaller companies in an index.
• ETF Selection

• Why these ETFs were selected: Based on Morningstar classifications, two ETF providers offered ETFs in this category at the time of ETF selection. While there are many indexing approaches that incorporate various fundamental factors, classifications for fundamental strategies within Schwab Intelligent Portfolios are based on Morningstar's classifications for index selection and index weighting (among other data points). Among the two ETFs in this category, FNDE was selected as the primary ETF because it had the lowest expense ratio at the time of ETF selection. PXH, which had a slightly higher expense ratio, was selected as the secondary ETF. Both ETFs had more than $1 billion in assets under management at the time of ETF selection and have traded with reasonable average bid-ask spreads historically.

• Why other ETFs were not selected: The category consists of just two ETFs.

• What is it?
  U.S. real estate investment trusts (REITs) are real estate related securities traded on U.S. exchanges. REITs invest in many underlying properties, including hospitals, shopping centers, office buildings, apartment buildings, and hotels. The IRS requires REITs to pay out at least 90% of their taxable income to unit holders every year. By doing so, REITs are often exempt from corporate income taxes on the portion of their income that is paid out to unit holders, avoiding the double taxation that many publicly traded companies experience.
• What role does it play in a portfolio?
  U.S. REITs can provide both inflation protection and income potential to a portfolio. REITs can also provide diversification to a portfolio of more traditional asset classes. Investors have long flocked to REITs (and real estate in general) because of their reputation as a hedge against inflation, as a way to increase diversification, and to generate income.
• When does it perform well?
  Since dividends from REITs generally increase with inflation, REITs tend to do better than most other asset class in moderate or high inflation environments.
• When does it perform poorly?
  REITs do poorly during recessions as occupancy rates and valuations may both fall in such environments. REITs also tend to do poorly during periods of rising interest rates when that rise isn't accompanied by higher inflation.
• ETF Selection

• Why these ETFs were selected: SCHH and USRT track market-cap weighted indexes of U.S. REITs, which are companies that own (and frequently manage) commercial and residential property. SCHH was selected as the primary ETF because it had the lowest expense ratio at the time of ETF selection. USRT also had a low expense ratio and was selected as the secondary ETF. Each of these ETFs are managed by firms with significant assets under management at the time of ETF selection.

• Why other ETFs were not selected: Among other ETFs in this category, iShares Cohen & Steers REIT (ICF) and iShares U.S. Real Estate (IYR) had significantly higher expense ratios at the time of ETF selection.

• What is it?
  International exchange-traded REITs are investments in real estate investment trusts focused on real estate and/or mortgage securities traded in foreign countries. Like most securities, REITs are exposed to potential downturns in specific sectors/regions of the real-estate markets and the broader economy and also contain additional risks due to potential leverage.
• What role does it play in a portfolio?
  International real estate is appealing for a number of reasons: It has the potential to deliver strong performance, attractive yields and diversification relative to traditional investments. In addition, investing in companies located overseas offers the potential to benefit from currency diversification. Foreign company returns are denominated in foreign currencies, so they provide some protection against a potential fall in the value of the U.S. dollar relative to those currencies.
• When does it perform well?
  As is the case with many other securities with exposure to real estate markets, international REITs typically perform well during declining interest rate environments and when banks are expanding their lending portfolios. They also tend to hold up well against inflationary pressures.
• When does it perform poorly?
  As is the case with most asset classes, recessions generally don't bode well for international exchange-traded REITs. Periods of sharply rising interest rates can also be difficult for this type of investment.
• ETF Selection

• Why these ETFs were selected:  Since U.S. REITs are a different asset class within Schwab Intelligent Portfolios, the ETFs selected here should target REITs from outside the U.S. HAUZ and VNQI provide well-rounded exposure to international REITs, and they have the lowest OERs in this category.

• Why other ETFs were not selected: SPDR^® Dow Jones International Real Estate ETF (RWX) (among the largest funds in this category) has historically traded with a narrow bid-ask spread, but it was not selected because it had a significantly higher expense ratio at the time of ETF selection. Among other ETFs in this category, iShares International Developed Property (WPS) and iShares International Developed Real Estate ETF (IFGL) also had higher expense ratios. 

• What is it?
  U.S. high dividend stocks represent the equity of U.S. companies that tend to distribute higher-than-average dividends to shareholders. These are typically large company stocks, as a higher percentage of large companies pay dividends compared with small companies. Historically, high dividend strategies have resulted in vastly different sector weights than market capitalization-weighted strategies. Currently within the S&P 500, a market-cap-weighted index, the largest sectors are Information Technology and Health Care. Within high dividend strategies the largest sectors have often been high dividend-yielding sectors such as Industrials. 
• What role does it play in a portfolio?
  These stocks typically are well-suited for investors seeking both growth and income from their investments because they deliver more predictable annual income than the average stock, may reduce volatility and could appreciate over time. Dividend-paying companies are generally perceived to be more stable than those that don't pay dividends because they are returning excess capital to shareholders.
• When does it perform well?
  High dividend paying stocks perform well in most markets.  They have exhibited particularly strong relative performance versus non-dividend paying equities during bear markets. Valuation matters as well. When prices are low relative to earnings, for example, subsequent price performance is more likely to be strong.
• When does it perform poorly?
  High dividend paying stocks may struggle to keep pace during more speculative bull market periods when stock price returns make up a larger portion of total returns, which include dividends plus stock price appreciation. Faster-growing companies that pay little or no dividends may see stronger stock price returns in this type of environment than companies that distribute earnings in the form of dividends rather than investing those earnings back into potential growth.
• ETF Selection

• Why these ETFs were selected: Finding the right fit in the high dividend category can be challenging, since a high dividend payment may not be sustainable or may be the result of a falling stock price. However, screens that are too restrictive can result in low yield and sector deviations that are inconsistent with asset class goals.

• At the time of ETF selection, SCHD held approximately 100 stocks with a history of fundamental strength and consistent dividend payments. SCHD was selected as the primary ETF because it had one of the lowest expense ratios at the time of ETF selection along with a history of trading with a narrow average bid-ask spread. VYM was selected as the secondary ETF as it provides a diversified portfolio of high dividend paying stocks, while still screening for dividend sustainability (stocks must be forecast to continue paying dividends for the next 12 months). Both ETFs have more than $40 billion in AUM and narrow bid-ask spreads.

• Why other ETFs were not selected: Among other ETFs in this category, Vanguard Dividend Appreciation ETF (VIG) was not selected as the secondary due to more representative asset class coverage by VYM. VIG limits its portfolio to stocks that have increased their dividend for at least 10 years, resulting in a lower yield than either SCHD or VYM. SPDR^® S&P Dividend ETF (SDY) and iShares Select Dividend (DVY) had higher expense ratios at the time of ETF selection.

• What is it?
  International high dividend stocks are investments in the equity of foreign companies that tend to distribute higher-than-average dividends. Dividend-paying companies are generally perceived to be more stable than those that don't pay dividends because they are returning excess capital to shareholders. As with most international assets, investing in international high dividend stocks involves additional risks, which include differences in financial accounting standards, currency fluctuations, geopolitical risk, foreign taxes and regulations, and the potential for illiquid markets.
• What role does it play in a portfolio?
  These stocks are well-suited for investors seeking both growth and income from their investments as well as international diversification. These investments offer the same potential benefits as domestic dividend generating securities, plus the added diversification benefits of international exposure.
• When does it perform well?
  High dividend stocks generally perform competitively with other stocks in most market climates, but tend to outperform relative to other stocks during market downturns. Valuation matters as well. When prices are low relative to, for example, earnings, subsequent price performance is more likely to be strong.
• When does it perform poorly?
  International developed high dividend stocks may perform poorly in higher return, more speculative markets where capital appreciation accounts for a higher percentage of total return.
• ETF Selection

• What is it?
  U.S. Securitized bonds are securities in which principal and interest payments are backed by cash flows from a particular asset or pool of assets.  Some of the most common assets used as collateral for these bonds include mortgages, automobile loans and credit card debt. Often these securities will be structured into various groups of assets, or tranches, based on the credit rating of the underlying debt. One type of securitized bond is a mortgage-backed security (MBS). Mortgage-backed securities are created by pooling mortgages purchased from their original lenders. As homeowners make their mortgage payments, those payments get passed on to MBS holders. As a result, mortgage-backed securities generally pay both interest and principal on a monthly basis. If the mortgages in the pool get paid off earlier than expected (from homeowner prepayments) then MBS investors would get their principal back more quickly. Some of the more common types of mortgage-backed securities are those guaranteed by the Government National Mortgage Association (Ginnie Mae) and those issued by the Federal National Mortgage Association (Fannie Mae) and the Federal Home Loan Mortgage Corporation (Freddie Mac). Ginnie Mae is backed by the full faith and credit of the U.S. government, while MBS issued by Fannie Mae and Freddie Mac are implicitly backed by the U.S. government. However, the U.S. government has no obligation to save either company from default. 
• What role does it play in a portfolio?
  Securitized bonds can help investors earn higher yields than Treasuries, while still investing in high quality investments. And since they generally pay interest and principal on a monthly basis, they can help those investors looking for income. However, the monthly payment can vary, based on the payment speeds of the underlying assets, such as mortgage payments. The uncertainty of monthly payments is one reason why MBS generally pay higher yields than Treasuries. Mortgage-backed securities can also help boost the credit quality of a portfolio, especially those guaranteed by Ginnie Mae. MBS generally have many of the same risks of traditional bonds (such as interest rate risk, credit risk and liquidity risk), but they also come with two unique risks—prepayment risk and extension risk. Prepayment risk occurs when homeowners pay their mortgages back more quickly and then the principal of the MBS gets paid more quickly. Extension risk occurs when homeowners prepay at slower rates, leading to a return of principal that takes longer than initially anticipated. 
• When does it perform well?
  Mortgage-backed securities generally perform well when interest rates are relatively stable or falling. Just like traditional bonds, the price and yields of MBS tend to move in opposite directions. However, because falling interest rates can lead to an increase in prepayments—due to homeowners refinancing their mortgages—the price of mortgage-backed securities might not rise as high as they would have in the absence of a prepayment option. In this case, price appreciation may be tempered, and because of an increase in prepayments, MBS investors are then left to reinvest at lower interest rates.
• When does it perform poorly?
  MBS perform poorly when interest rates are rising. When interest rates rise, investors are less likely to prepay their mortgages, since they would likely have to refinance at a higher rate. This means that it can take longer to get your money back, meaning it will likely take longer to invest in those higher yields. And like Treasury bonds, higher MBS yields lead to lower prices. If long-term interest rates rise, mortgage-backed securities tend to perform poorly.
• ETF Selection

• What is it?
  U.S. inflation protected bonds are securities issued by the U.S. Treasury that protect investors against inflation by adjusting the principal value based on changes in the U.S. Department of Labor's Consumer Price Index. Like traditional Treasury bonds, they are backed by the full faith and credit of the U.S. government. Inflation protected bonds pay interest on a semi-annual basis, based on a fixed rate at issuance. The actual coupon payment may vary, since that fixed coupon rate is based on principal that adjusts for inflation or deflation. Inflation protected bonds are issued several times a year, with initial maturities of 5, 10, and 30 years. However, due to the passage of time, these bonds can be bought in the secondary market with various maturities. The principal value rises with inflation, and falls with deflation. The coupon payment is always based on the adjusted principal, even if it falls below its initial par value due to deflation. However, at maturity, investors will always receive the greater of the adjusted par value or its initial par value. In other words, the initial principal amount of an inflation protected bond is protected from deflation, but the coupon payments are not.
• What role does it play in a portfolio?
  In 1997, the U.S. Treasury introduced inflation protected bonds as a means of protecting against the corrosive impact of inflation. With these bonds, the principal value adjusts upward with inflation, and downward with deflation. Inflation protected bonds can be a good addition to a fixed income portfolio for investors to help protect against the impact of inflation on their fixed income holdings.
• When does it perform well?
  U.S. inflation protected bonds generally perform well when inflation rises, since the principal and coupons would both rise as well. The bonds may also perform well when inflation expectations rise, as investor demand can push the prices higher relative to traditional U.S. Treasuries, as investors seek inflation protection. Inflation protected bonds are still bonds whose prices and yields move in opposite directions. If traditional Treasury bond yields are falling, inflation protected bonds' yields may follow suit, pushing prices higher.
• When does it perform poorly?
  Inflation protected bonds generally perform poorly if inflation is declining, outright deflation takes hold, or inflation expectations decline. If expectations for future inflation are tame, investors may prefer traditional Treasury bonds, pushing inflation protected bond prices lower. Also, if Treasury yields rise without an accompanying rise in inflation, inflation protected bond prices would likely fall as well.
• ETF Selection

• Why these ETFs were selected: SCHP and SPIP both hold Treasury inflation-protected securities (TIPS) issued by the U.S. Treasury and representing a broad range of durations. These two funds each had more than $2 billion in assets under management and both ETFs have a history of closely tracking their underlying indexes and trading with relatively narrow bid-ask spreads.

• Why other ETFs were not selected: iShares TIPS Bond (TIP) is the largest ETF in the category but had a higher expense ratio at the time of ETF selection. Among other ETFs in this category, Vanguard Short-Term Inflation-Protected Securities ETF (VTIP) and iShares 0-5 Year TIPS Bond ETF (STIP) limit their holdings to short durations.

• What is it?
  U.S. corporate high yield bonds—sometimes known as "junk bonds"—are investments in the debt of US corporations with lower credit ratings provided by the major U.S. credit rating agencies. High yield bonds have ratings of BB+ or below by Standard and Poor's and Ba1 or below by Moody's Investors Services. That low rating indicates that these companies have relatively high default risk, meaning that the issuer is much more likely to not be able to meet its debt payment obligation as compared to an investment grade bond. Because these bonds are riskier than those issued by entities with investment-grade credit ratings, they generally pay a higher interest rate than a comparable investment grade bond.
• What role does it play in a portfolio?
  High yield corporate bonds generally offer higher yields than investment grade corporate bonds, so they offer the potential to enhance the total return of a portfolio even more. Like investment grade corporate bonds, high yield corporate bonds allow investors to diversify by issuer, industry, maturity, and credit rating, among others. However, the diversification benefits that high yield corporate bonds offer are different from investment grade corporate bonds. High yield bonds have therefore tended to behave like stocks in times of distress, and might not necessarily help protect the downside like U.S. Treasuries or investment grade corporates might.
  
  High yield corporate bonds enjoy a yield advantage—called a credit spread—over comparable U.S. Treasuries, and the advantage is more than investment grade corporate bonds, though high-yield bonds also come with a greater risk of default. The high yield bond market is smaller than that of the investment grade corporate bond market, and the deal size of high yield bonds is smaller than that of investment grade corporate bonds, on average. This reduces the overall liquidity and leads to greater volatility for high yield corporate bonds.
• When does it perform well?
  High yield corporate bonds tend to perform well when the economy is strong and default rates are low and are expected to remain low. In addition to the higher yields that corporate bonds offer, high yield corporate bonds can experience price appreciation as well. The yield advantage that corporate bonds offer relative to Treasuries is called a credit spread; it can be thought of as compensation for the extra risks they have. If the economic outlook is strong or default rates are expected to remain low, investors may accept lower compensation, as the perceived risks of default may decline. When the credit spread falls, the price of corporate bonds generally rises relative to U.S. Treasury bonds.
• When does it perform poorly?
  High yield corporate bonds tend to perform poorly if economic growth slows and defaults are expected to rise. High yield corporate bonds tend to be much less liquid than investment grade corporate bonds, and are much more prone to significant sell-offs. For example, the Bloomberg U.S. Corporate High Yield Index suffered a total return of -26.2% in 2008 as expectations of a surge in defaults materialized. According to Moody's Investors Services, the trailing 12-month speculative grade default rate rose as high as 14% in 2009. In contrast, the Bloomberg U.S. Corporate Bond Index, a proxy for investment grade corporate bonds, only suffered a loss of -4.94% in 2008.
• ETF Selection

• What is it?
  International developed country bonds are debt instruments issued by a government, agency, municipality or corporation domiciled in a highly developed country other than the U.S. They may be issued in the home currency of the country of origin or denominated in U.S. dollars or some other currency. International developed country government bonds typically carry investment grade credit ratings, but some may be rated below investment grade. Corporate bonds issued in developed market countries may be investment grade or sub-investment grade.
• What role does it play in a portfolio?
  International developed market bonds share several characteristics of securities issued by the U.S. government and corporations, but also offer geographic diversification benefits and exposure to international markets that may be at a different stage of the business cycle than the U.S. at any given time. If the bonds are denominated in a foreign currency, there can be a benefit from diversification from the U.S. dollar if the dollar is declining.
• When does it perform well?
  International developed market bonds tend to perform well when the U.S. dollar is declining against other major currencies and/or interest rates in the U.S. are low relative to other major countries. As with all bonds, performance is strongest when interest rates and inflation are falling. When foreign bond yields are higher than U.S. yields for comparably rated bonds of similar maturity, investors often buy foreign bonds to capture the more attractive yields. They have also historically performed well when the U.S. stock market is declining, as that often leads investors to shift out of U.S. securities and into other markets. 
• When does it perform poorly?
  International developed market bonds tend to perform poorly when the U.S. dollar is rising and/or interest rates and inflation are rising. Country specific events can affect the performance of international bonds as well, such as rising government budget deficits or adverse political developments. Monetary policies also affect the performance of international developed country bonds, both in terms of the direction of interest rates and credibility. A country with a central bank that has a history of managing inflation well may pay less interest on its bonds than one where lax central bank policies have allowed inflation to be higher. International corporate bonds, much like U.S. corporate bonds, tend to perform poorly when the issuing company is experiencing poor growth in earnings or perhaps has increased its balance sheet leverage through high borrowing.
• ETF Selection

• Why these ETFs were selected: Both BNDX and IAGG offer currency-hedged exposure to international bonds issued by both governments and corporations in developed markets. By hedging currency exposure to the U.S. dollar, these funds aim to capture interest rate differentials (i.e. higher interest rates in foreign markets as compared to those in the U.S.) without exposing U.S. investors to volatile currency fluctuations. Additionally, both funds are broadly diversified by maturity and overwhelmingly investment grade. They also trade with low bid-ask spreads.

• Why other ETFs were not selected: The category consists of just two ETFs that meet asset class objectives and other criteria.

• What is it?
  International emerging market bonds (EM bonds) are issued by a government, agency, municipality or corporation domiciled in a developing country. These investments typically offer higher yields to reflect the elevated risk of default, which can stem from underlying factors such as political instability, poor corporate governance and currency fluctuations. The asset class is relatively new compared with other sectors of the bond market. Indices that track EM bonds only date back to the 1990s when the market became liquid and actively traded. EM bonds may be denominated in local currency or in U.S. dollars or other major currencies. While some EM countries have taken on the characteristics of developed market economies, with more stable fiscal and monetary policies and sounder financial institutions, there remain wide differences among the countries categorized as emerging markets.
• What role does it play in a portfolio?
  An allocation to EM bonds can provide investors with a source of higher income than developed market bonds might offer and the potential for capital appreciation. The potential upside, however, comes with more risk. Defaults among EM bonds have historically been higher than for developed market bonds. EM bonds tend to be more highly correlated with equities than with U.S. Treasuries or developed market international bonds. The correlation between U.S. dollar-denominated EM bonds, as measured by the Bloomberg Emerging Markets USD Aggregate Bond Index and the S&P 500 for the 20-years ending March 2022, was 0.57. EM bonds, if denominated in local currency, can provide another source of diversification in a portfolio. However, EM currencies also tend to be much more volatile than developed market currencies. Corporate bonds issued by companies in EM countries can offer access to fast-growing economies with higher yields than might be available in developed market corporate bonds.
• When does it perform well?
  EM bonds tend to perform well when the U.S. dollar and other major currencies like the euro or Japanese yen decline because EM assets look more attractive by comparison. A growing global economy tends to benefit EM country bonds as well since exports generally represent a bigger proportion of EM economies. A low interest rate, low volatility environment has also tended to be positive for EM bonds because investors are attracted to the higher interest rates EM bonds offer.
• When does it perform poorly?
  In addition to the factors that contribute to the poor performance of developed country bonds, EM bonds tend to perform poorly when investors are averse to taking risk or when global growth slows. Since many EM countries derive much of their growth from exports to developed countries, slower growth in trade globally tends to be a negative factor for the economies and currencies of EM countries.
• ETF Selection

• What is it?
  Preferred stocks are often referred to as a "hybrid" investment, sharing characteristics of both stocks and bonds. As a stock, they are generally paid after a company's bonds in the event of a corporate liquidation. Similar to a bond, however, they have a fixed par value, generally make regular fixed payments, and their market value can rise or fall as interest rates change. Preferred stocks are senior to common stock—meaning their holders have priority over holders of common stock in the event of a claim on the company's assets—and some rank as high as senior unsecured bonds. Preferred stocks are most commonly issued in the Financials, Industrials and Utilities sectors. Most preferred stocks have a call feature allowing the issuer to purchase the stock back from the investor at a certain price and date. Call features can be a benefit to issuers, providing them with flexibility. Unlike common stock, preferred stocks do not come with voting rights. 
• What role does it play in a portfolio?
  Preferred securities can help investors earn a higher yield and potentially enhance the overall total return of a portfolio. However, they do come with some unique risks. An issuer's preferred securities will usually have a lower credit rating than the firm's senior, unsecured bonds, due to the weaker guarantees of the income payments. Also, preferred securities tend to be issued by financial institutions, meaning it's difficult to have a preferred securities portfolio that is well diversified among various sectors. And there are significantly fewer preferred securities issuers than there are corporate bond issuers, so it's more difficult to be diversified by issuer as well.
• When does it perform well?
  Preferred securities tend to do best when long-term bond yields are stable or falling, and the economic outlook is positive. Preferred securities have two key risks: interest rate risk and credit risk. If long-term interest rates are falling, the prices of preferred securities would likely rise. Preferred securities tend to have high durations, a measure of interest rate sensitivity, so their prices are very sensitive to a fall in interest rates. Also, preferred securities may perform well when investors demand less of a credit spread to hold them, which would push their prices higher relative to U.S. Treasuries.
• When does it perform poorly?
  Preferred securities tend to do poorly when long-term interest rates are rising, due to their relatively high durations. Preferred securities also tend to do poorly when the perceived credit risk of the corporate market increases, as the risk rises that issuers could suspend the dividend or interest payments.
• ETF Selection

Why these ETFs were selected: PFFD and PSK were selected as the primary and secondary ETFs because each provides broad, diversified exposure to this asset category and has traded historically with a relatively narrow average bid-ask spread. Our primary ETF, PFFD is also the lowest cost ETF in this asset class.

Why other ETFs were not selected: VanEck Preferred Securities ex Financials ETF (PFXF) excludes securities of financial institutions. These securities make-up as much as 75% of the preferred market, so PFXF did not provide the intended broad asset class coverage. Other ETFs either had higher expense ratios or held only a subset of the preferred securities available in this asset class (e.g., only preferred securities issued by financial firms or REITs).

• What is it?
  Bank loans are loans that banks make to commercial borrowers, who use them to fund acquisitions and other strategic initiatives. These loans then are often sold to investment vehicles like mutual funds and exchange-traded funds (ETFs). The loans typically have floating coupon rates, meaning they pay a set amount over a benchmark interest rate, often the three-month London Interbank Offered Rate (LIBOR). Bank loans are generally rated below investment grade, meaning BB+ or below by Standard & Poor's or Ba1 or below by Moody's Investors Service, and as a result typically carry higher yields. Because they pay a floating rate, bank loans are often used as a hedge against rising interest rates. Bank loans are usually "secured," which means that they are backed by a pledge of the issuer's assets, such as inventories or receivables. They also generally are senior to most other corporate debt, so in default, they would get paid before the issuer's other corporate bonds. Due to bank loans' senior and secured status, they generally have higher recovery rates than traditional corporate bonds in the case of a default. 
• What role does it play in a portfolio?
  Under certain conditions, these types of loans and notes can be attractive to investors who think short-term interest rates may rise. Since they are rated below investment grade, they should be considered an aggressive investment relative to other types of fixed income. The coupons are tied to short-term interest rates. If long-term interest rates rise, the coupons on bank loans would likely be unaffected. Also, most bank loans have a "Libor floor," which is the minimum rate for Libor on which the coupon will be based. This means that Libor would need to rise to that level before the coupons started to adjust higher.
• When does it perform well?
  Bank loans tend to perform well when short-term interest rates—specifically 3-month Libor—are rising and default rates remain low. In this scenario, investors can benefit from higher coupons payments, with less risk of prices falling due to defaults. Bank loans also perform well when market volatility is lower, since they tend to suffer from low liquidity.
• When does it perform poorly?
  Bank loans can perform poorly when short-term interest rates are falling. In this scenario, the coupon payments would decline, likely reducing the total return. Bank loans tend to perform poorly when the economy is expected to slow and defaults rates are rising or expected to rise. Despite their "senior, secured" status, bank loans are still aggressive investments.
• ETF Selection

• Why this ETF was selected: BKLN is currently the only ETF in this asset class that meets our eligibility criteria. BKLN has large assets under management and has historically traded at an acceptable narrow bid-ask spread.

• Why other ETFs were not selected: No other ETFs in this asset class met our eligibility criteria.

• What is it?
  Investment grade municipal bonds are issued by municipalities—cities, states, and counties—as well as enterprises that serve a public purpose, such as universities, hospitals, and utilities. These investments generally receive high credit ratings from the major rating agencies. The coupon payments made by these bonds are typically exempt from federal and state income tax (if issued by a municipality located within the investor's home state). 
• What role does it play in a portfolio?
  Investment grade municipal bonds combine strong historic creditworthiness and tax advantages. Interest income earned on most municipal bonds is not subject to federal taxes, an advantage compared to corporate and Treasury bonds for investors in higher tax brackets or investing in taxable accounts. Like other bonds, they often move in the opposite direction of stocks, so they can provide diversification benefits as well as income.
• When does it perform well?
  Like most bonds, investment grade municipal bonds tend to perform best when interest rates are falling and inflation is low. Money used to pay municipal bonds tends to be tied to tax revenues or usage fees, so they often perform well when the economy is improving and tax receipts or usage is high. Municipal bonds tend to perform similarly to Treasury and corporate bonds, based on changes in market interest rates. Other factors, however, can cause differences in performance including higher or lower demand for the tax advantages. Already issued municipal bonds often tend to trade infrequently compared to many other fixed income markets. Therefore, municipal bonds may also do well compared to other fixed income investments when the amount of newly issued municipal bonds is low because the scarce supply can drive prices up.
• When does it perform poorly?
  When interest rates are rising or inflation is high, investment grade municipal bonds tend to perform poorly. They also tend to perform poorly when, among other things, municipal credit conditions are deteriorating (often driven by lower tax revenues or higher municipal expenses). The municipal bond market is also more prone to headline risk—or the risk that investors will sell their investments due to a single negative event that is not actually impacting the rest of the market—compared to other markets. Because municipal bonds pay interest that is generally exempt from federal taxes, lower federal tax rates make municipal bonds less attractive compared with other taxable fixed income investments because it reduces the benefit of the tax exemption. While the municipal bond market has a lot of debt outstanding, the size of this market is much smaller than others such as U.S. Treasuries. This smaller size increases the potential liquidity risk, which can drive down prices when selling into an illiquid market.
• ETF Selection

• What is it?
  Investment grade California municipal bonds are investments in bonds issued by municipalities and enterprises in the State of California. These investments generally have high credit ratings from various rating agencies. The coupon payments made by these bonds are exempt from federal and California state income tax for California residents.  However, other taxes may apply. For example, tax-exempt income may be subject to the Alternative Minimum Tax (AMT), capital appreciation from bond funds and discounted bonds may be subject to state or local taxes, and capital gains are not exempt from federal income tax. Despite the high-profile credit problems of some municipalities, most U.S. cities have been able to cut spending or increase revenue to support payments even during tough economic times, and so historically, defaults for investment-grade municipal bonds have been exceedingly rare. 
• What role does it play in a portfolio?
  Investment grade municipal bonds combine strong historical creditworthiness and tax advantages, with an additional tax advantage for California residents. Like most other bonds, they tend to have lower correlations with stocks, so they can also provide diversification benefits.
• When does it perform well?
  Like most municipal bonds, investment grade California municipal bonds tend to perform best when interest rates are falling and inflation is low. Money used to pay municipal bonds tends to be tied to tax revenues or usage fees, so they often perform well when the economy is improving and tax receipts or usage is high. Already issued municipal bonds often tend to trade infrequently compared to many other fixed income markets. Therefore, municipal bonds in general may also tend to perform well compared to other fixed income investments when the amount of newly issued municipal bonds is low because the scarce supply can drive prices up.
• When does it perform poorly?
  When interest rates are rising or inflation is high, investment grade California municipal bonds tend to perform poorly. They also tend to perform poorly when the local economy is deteriorating. This can impact tax revenue or usage fees, which are generally tied to the source of repayments for municipal bonds. Compared with other markets, the municipal bond market is also more prone to headline risk—or the risk that investors will sell their investments due to a single negative event that is not actually impacting the rest of the market. While California has a large amount of debt outstanding, the size of its market is much smaller than others such as U.S. Treasuries. This smaller size increases potential liquidity risk, which can drive down prices when selling into an illiquid market.
• ETF Selection

• Why these ETFs were selected: These are the only two ETFs meeting all selection criteria that provide dedicated exposure to California municipal bonds. PWZ and CMF have both traded historically with reasonable bid-ask spreads. Both funds are AMT-free.
• Why other ETFs were not selected: There were no other ETFs meeting all selection criteria in this category at the time of ETF selection.