Income Portfolio Strategy Disclosure
For BlackRock Target Income Portfolios
The BlackRock income portfolio strategy (“income portfolio”) is constructed entirely of bond exchange-traded funds (“ETFs”). The income portfolio differs from the Betterment Portfolio (“Betterment’s core portfolio”) by eliminating entirely exposure to stocks. Additionally, the income portfolio is actively managed by BlackRock (the portfolio designer) to achieve particular exposures to certain combinations of ETFs at specific times. Investors who select the Betterment income portfolio can choose between four different yield/risk profiles. The higher the expected risk, the higher the projected yield. For additional description of how the portfolios are constructed, please see http://www.betterment.com/resources/income-portfolio-strategy/
The ETFs in the income 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 income portfolio as soon as possible after they are communicated by BlackRock, there may be a delay of up to ten business days.
BlackRock constructs the Betterment income portfolio entirely with its own ETFs. Because BlackRock earns management fees from the ETFs selected for the income portfolio, BlackRock has a financial incentive to select higher cost ETFs for inclusion in the portfolio. Additionally, investors in the income portfolio may forego 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 income portfolio. Additional detail regarding the ETFs included in the income 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 income portfolio differs from Betterment’s core portfolio. Investors should consider these differences when deciding whether they wish to elect the income portfolio.
The income portfolio is less diversified than Betterment’s core portfolio because it does not provide an investor with any exposure to stocks. Historically, bonds offer a lower expected return and a lower expected risk than stocks. However, 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. Additional information regarding the benefits of diversification can be found at: http://www.betterment.com/resources/investment-strategy/portfolio-management/seeking-diversification-alpha/
Some of the ETFs in the income 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 income 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 income 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 income portfolio is actively managed by BlackRock. Accordingly, the income 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.
Investors in the income portfolio will incur additional fund costs compared to investors in Betterment’s core portfolio because the ETFs in the income Portfolio have higher aggregate expense ratios than the funds used in Betterment’s core portfolio. The specific fees for each fund in the income 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 income portfolio for taxable accounts, and investors should consider them carefully before electing the income 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 income portfolio may be taxed at higher rates than the dividends and interest earned in Betterment’s core portfolio. The income 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 income portfolio. Additionally, investors in the income 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 income portfolio. For goals for which the income portfolio is elected, Betterment’s tax loss harvesting feature will not work, but tax loss harvesting will continue to work for goals in taxable accounts for which the income portfolio is not elected, although there may be reduced opportunities for TLH to harvest losses in these goals. See Betterment’s TLH disclosures for further detail. Betterment will not recommend a glide path for goals for which the income portfolio is elected, and Betterment’s auto-adjust feature is unavailable for the income portfolio. Additionally, a tax coordinated portfolio cannot include a goal for which the income portfolio has been elected.
In addition, Betterment’s automatic rebalancing feature will work differently for the income portfolio than for Betterment’s core portfolio. Betterment’s core portfolio is rebalanced through cash flows only (i.e., dividends and interest, deposits, and withdrawals) until the portfolio has drifted by more than 3% from its target allocation. A 3% drift will trigger the purchase and sales of securities to rebalance the account back to the target allocation (“hard rebalancing”), but only as long as those purchases and sales do not trigger short-term capital gains. In other words, Betterment’s core portfolio prioritizes minimizing short-term capital gains ahead of drift reduction. Investors who elect Betterment’s core portfolio can turn off hard rebalancing by contacting Betterment’s customer support team. However, the income portfolio prioritizes achieving the target allocation designed to return the expected yield ahead of minimizing short-term capital gains. This means that the income portfolio may be subject to hard rebalancing even if it causes an investor to incur short-term capital gains. Investors will not be able to turn off hard rebalancing for goals for which they elect the income 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.
Last updated: March 31, 2020