The BlackRock Variable Bonds portfolio strategy ("Variable Bonds portfolio") is constructed entirely of bond exchange-traded funds (“ETFs”). The Variable Bonds portfolio differs from the Betterment Portfolio strategy (“Betterment’s core portfolio”) by eliminating exposure to stocks entirely. Additionally, the Variable Bonds portfolio is designed and actively managed by BlackRock to achieve particular exposures to certain combinations of ETFs at specific times. Investors who select the BlackRock Variable Bonds portfolio can choose between four different yield/risk profiles. The higher the expected yield, the higher the expected risk. For additional information on how the portfolios are invested, please see Variable Bonds Portfolios from BlackRock.
The ETFs in the Variable Bonds portfolio and their allocations are selected in the first instance by BlackRock. Betterment places trades to achieve the designated ETF allocations but retains discretionary authority not to place trades to implement a portfolio update provided by BlackRock if Betterment determines that the update would be inconsistent with a client’s investment direction. Although Betterment will endeavor to implement changes to the Variable Bonds portfolio as soon as possible after they are communicated by BlackRock, Betterment retains discretion on whether and when to implement any such changes.
Because BlackRock sets the fund fees (expense ratio) for BlackRock ETFs selected for the Variable Bonds portfolio, BlackRock has a financial incentive to select its own funds for inclusion in the portfolio, even if those funds have higher costs than comparable ETFs offered by other fund managers. Investors in the Variable Bonds portfolio may forgo the opportunity to invest in bond ETFs offered by other fund managers, some of which may have lower expense ratios or more attractive yield/risk profiles than the ETFs selected for inclusion in the Variable Bonds portfolio. Additional detail regarding the ETFs included in the Variable Bonds portfolio can be found in the prospectuses drafted by the managers of those funds. Copies of those prospectuses are available in the portfolio tab of your Betterment account.
There are several ways that the Variable Bonds portfolio differs from Betterment’s core portfolio. Investors should consider these differences when deciding whether they wish to elect the Variable Bonds portfolio.
The Variable Bonds portfolio is less diversified than Betterment’s core portfolio because it does not provide an investor with any exposure to stocks. A diversified portfolio containing both stocks and bonds may increase the risk-adjusted return relative to an all bond portfolio because stock and bond prices do not always move together.
Some of the ETFs in the Variable Bonds portfolio may be less liquid than funds used in Betterment’s core portfolio. This means that it may be more difficult to buy and sell certain ETFs in the Variable Bonds portfolio without affecting their prices, relative to the bond ETFs in Betterment’s core portfolio. As a result, there may be increased trading costs to enter or exit positions in the Variable Bonds portfolio relative to funds representing the same sub-asset classes in Betterment’s core portfolio. This also may result in wider discrepancies between the market prices of the ETFs and the prices of their underlying baskets of bonds than for comparable ETFs in Betterment’s core portfolio, particularly during times of market stress.
While Betterment’s core portfolio is comprised of ETFs that passively track benchmark indices for their respective asset classes, the Variable Bonds portfolio is actively managed by BlackRock. Accordingly, the Variable Bonds portfolio is subject to the risk that the fund manager may underperform the benchmark and/or not achieve the target yield for the portfolio, regardless of how the manager has performed in the past. Actively managed portfolios also are subject to style drift, meaning that active managers could take positions that are more or less risky than the target yield/risk profile. For example, portfolios may include bonds of longer duration that are sensitive to interest rate risk or bonds of lower credit quality.
Investors in the Variable Bonds portfolio will incur additional fund costs compared to investors in Betterment’s core portfolio because the ETFs in the Variable Bonds portfolio have higher aggregate expense ratios than the funds used in Betterment’s core portfolio. The specific fees for each fund in the Variable Bonds portfolio are listed in the funds’ prospectuses, which are available on the portfolio tab in your account. The fees for each yield/risk profile are subject to change, as BlackRock may alter at any time either the allocation of the funds used in any yield/risk profile or the expense ratios of the funds.
There are significant potential downsides to electing the Variable Bonds portfolio for taxable accounts, and investors should consider them carefully before electing the Variable Bonds portfolio for a taxable account goal. Depending on the relative allocation between stocks and bonds in Betterment’s core portfolio, the dividends and interest earned in the Variable Bonds portfolio may be taxed at higher rates than the dividends and interest earned in Betterment’s core portfolio. The Variable Bonds portfolio also does not contain exposure to municipal bonds, which are subject to favorable tax treatment relative to the bonds that are included in the Variable Bonds portfolio. Additionally, investors in the Variable Bonds portfolio may incur short-term capital gains in taxable accounts, as described in more detail below.
There are several features of Betterment’s service that either will not work or will work differently for the Variable Bonds portfolio. For goals for which the Variable Bonds portfolio is elected, Betterment’s tax loss harvesting feature will not work. Tax loss harvesting will continue to work for non-Variable Bonds portfolios in taxable accounts, although there may be reduced opportunities for TLH to harvest losses. See Betterment’s TLH disclosures for further detail. Betterment will not recommend a glide path for goals for which the Variable Bonds portfolio is elected, and Betterment’s auto-adjust feature is unavailable for the Variable Bonds portfolio. Additionally, the Variable Bonds portfolio cannot be elected for a tax coordinated goal.
Investing portfolios require a portfolio minimum balance in order for a rebalancing transaction to occur (which can be the aggregate of balances in a tax-coordinated portfolio), see Betterment’s portfolio minimum disclosures for further details. Rebalancing for Betterment’s core portfolio prioritizes minimizing short-term capital gains ahead of drift reduction when possible. Investors who elect Betterment’s core portfolio can turn off rebalancing by contacting Betterment’s customer support team. However, the Variable Bonds portfolio prioritizes achieving the target allocation designed to return the expected yield ahead of minimizing short-term capital gains. This means that the Variable Bonds portfolio may be subject to rebalancing even if it causes an investor to incur short-term capital gains. Investors will not be able to turn off rebalancing for goals for which they elect the Variable Bonds portfolio. These considerations are applicable for taxable goals only; tax-advantaged accounts (such as IRAs) can be rebalanced at any time without incurring capital gains taxes.