Managing Director & Head of ETF Product Development
For many investors, income generation is the most difficult portfolio mandate to fulfill. Here, Nuveen’s Head of ETF Product Development, Jordan Farris discusses his firm’s unique take on the bond space and how it could offer solutions to investors faced with the dilemma of a low-rate environment.
Given the unprecedented times we’re living in, what are the implications that income-oriented investors need to think about now and in the future?
There are a number of challenges that investors are facing today: an aging population in need of more income, a lower-for-longer rate environment and an uncertain political climate during a global pandemic. The confluence of these events has led investors and advisors to contemplate multiple scenarios when working through how to structure the income-focused portion of their portfolios.
However, with yields at historic lows, investors may hesitate to choose between reducing the amount of income they receive and increasing the amount of risk in their portfolio. To balance the two, Nuveen offers solutions to help them identify ways to generate higher yields, while minimizing exposure to the sources of risk that may fall outside of their risk tolerance budget.
How can duration and credit be used to fine-tune portfolios to align better with investors’ goals in terms of income risk and total return?
At Nuveen, we leveraged our expertise in generating income while balancing risk; the results of which can be seen in our fixed income ETFs, including the Nuveen Enhanced Yield U.S. Aggregate Bond ETF (NUAG) and the Nuveen Enhanced Yield 1-5 Year U.S. Aggregate Bond ETF (NUSA). These products are designed to increase the yield of traditional intermediate and short duration benchmarks—which are both fully investment grade—by tilting the weights of the underlying securities toward those with higher yields.
The shift toward those higher-yielding securities is done while simultaneously constraining characteristics that could bring unwanted volatility to a portfolio. Duration, sector exposure, tracking error and importantly, turnover, are all constrained so as to provide a better balance of yield and risk.
As an example, at each rebalance, the duration of NUAG’s benchmark index will always be within three months of the traditional core fixed income benchmark from which it was designed. This provides flexibility within the rules-based methodology to take on slightly more duration if it supports a higher level of income. This robust process helps to support our investment objective, and to provide 15% to 20% more income, as compared with traditional core fixed income benchmarks over full market cycles.
How is ESG analysis used to evaluate risk in fixed income? Is it unique to Nuveen?
The last five years has seen a steep increase in the number of ESG-branded products. The majority of these products have been equity-focused, but an increase in the quantity and quality of data has provided some of the more innovative asset managers—Nuveen included—the opportunity to integrate environmental, social and governance criteria into fixed income ETFs.
In our ESG ETF suite, we offer traditional aggregate bond exposure through the Nuveen ESG U.S. Aggregate Bond ETF (NUBD), and high yield exposure through the Nuveen ESG High Yield Corporate Bond ETF (NUHY). Combined with our full suite of equity ESG ETFs, both NUBD and NUHY have given clients the opportunity to align their personal values, across the entirety of their portfolios, as opposed to being limited to a certain sleeve or a certain asset class.
We’ve recently witnessed somewhat of a shift in the perception that investors have had to sacrifice performance when investing in ESG. This was driven by the fact that many ESG products have performed well this year, especially during periods of higher volatility. A consistent reason for that outperformance was the overweighting of stocks and bonds with higher ESG scores, while avoiding those that have lower ESG scores.
There’s a common misperception about liquidity issues with fixed income ETFs. Would you comment on that?
One of the biggest benefits of the ETF wrapper is its ability to function as a liquidity mechanism for transacting in the fixed income markets when other sources of liquidity may not be there. ETFs are bought and sold throughout the day at market price on the exchange. The market price is generally very close to the net asset value, or the “NAV,” of the ETF. However, during periods of higher volatility, like we experienced earlier this year, the gap between market prices and the NAVs, in some cases, widened. It is important for investors to have a well-formed execution strategy for ETF trades.
An example of this is using a limit order to secure a specific price or using a market order to execute the order more quickly. Both give the investor a tool for accessing liquidity within the fixed income ETF market, but we encourage investors to learn and understand both so as to be able to access this liquidity in the most effective way for their unique needs.
How do you see the fixed income ETF market evolving and expanding during the next three to five years?
At present, more than 400 of the 2,400-plus ETFs listed in the U.S. are fixed income focused. And more than 100 of those are actively managed. So the preponderance of the actively managed ETF assets exists within fixed income strategies. We think that 100 will increase substantially as more asset managers begin to distribute active fixed income capabilities through the ETF wrapper.
Bigger picture: More than $1 trillion is invested in fixed income ETFs in the U.S. As investors become more comfortable using the ETF as a delivery mechanism for income-focused strategies, it would not be surprising if those assets reached between $2 trillion and $3 trillion over the next three to five years.
This material is not intended to be a recommendation or investment advice; does not constitute a solicitation to buy, sell or hold a security or an investment strategy; and is not provided in a fiduciary capacity. The information provided does not take into account the specific objectives or circumstances of any particular investor, nor does it suggest any specific course of action. Investment decisions should be made based on an investor’s objectives and circumstances and in consultation with his or her financial professionals.
A word on risk
Investing involves risk; principal loss is possible. Interest rate risk occurs when interest rates rise, causing bond prices to fall. Credit risk arises from an issuer’s ability to make interest and principal payments when due, as well as the prices of bonds declining when an issuer’s credit quality is expected to deteriorate. For NUHY, investments in below-investment-grade or high yield securities are subject to liquidity risk and heightened credit risk. For NUBD and NUHY, because the indexes select securities for inclusion based on environmental, social and governance (ESG) criteria, the funds may forgo some market opportunities available to those that don’t use these criteria. There is no guarantee the Funds’ investment objectives will be achieved. ETFs seek to generally track the investment results of an index; however, a fund may underperform, outperform or be more volatile than the referenced index. These and other risk considerations are described in detail in the Funds’ prospectuses.
Shares of ETFs are bought and sold at market price as opposed to net asset value. As a result, an investor may pay more than net asset value when buying, and receive less than net asset value when selling. In addition, brokerage commissions will reduce returns. Fund shares are not individually redeemable directly with the Fund, but blocks of shares may be acquired from the Fund and tendered for redemption to the Fund by certain institutional investors in Creation Units.
Before investing, carefully consider Fund investment objectives, risks, charges and expenses. For this and other information that should be read carefully, please request a prospectus or summary prospectus from your financial professional, contact Nuveen at 800.257.8787 or visit nuveen.com.
Nuveen, LLC provides investment advisory solutions through its investment specialists. Nuveen Securities, LLC, member FINRA and SIPC. Nuveen, LLC and its affiliates are not affiliated with ETF.com/ETF Report.