Smart Beta Bond ETFs Hiding In Plain Sight

May 25, 2017

A Nonpartisan Approach To Risky Sectors
In riskier segments of the fixed-income market—such as high yield or emerging market debt—equal-weighting strategies have gained traction, as investors seek to avoid making too strong a bet in any one issue or country.

Two good examples include the equal-weighted PCY, which is one of the largest emerging market debt funds, smart beta or no; and the PowerShares Global Short Term High Yield Bond Portfolio (PGHY), which tracks high-yield debt in developing and emerging markets.

Factor Investing
Just as in the equity space, factor investing is a popular nonvanilla alternative in fixed income. The PowerShares Fundamental High Yield Corporate Bond Portfolio (PHB), for example, weights junk bonds according to issuer financial data. The IQ Enhanced Core Plus Bond US ETF (AGGP), meanwhile, is a fund-of-funds that allocates to sectors with higher momentum.

Quasi-Active Strategies
Several smart-beta bond ETFs take their cues from active strategies. The WisdomTree Barclays Yield Enhanced U.S. Aggregate Bond Fund (AGGY), for example, uses a sector rotation strategy to optimize yield, while the PowerShares 1-30 Laddered Treasury Portfolio (PLW) applies equal weighting to a bond ladder. The Vident Core U.S. Bond Strategy ETF (VBND), meanwhile, applies a multifactor strategy to the broad market, based on sector tail risk, valuations and corporate governance.

Smart Beta’s Future In Bonds Not Guaranteed
Whether investors cotton to the presence of smart-beta bond ETFs probably has less to do with branding and more to do with where the bond market goes next. 

With rates back on the rise, funds that hedge interest rate risk are sure to do well. (Indeed, TDTT and TDTF have dominated net flows into smart-beta bond ETFs since the start of the year.)

At the same time, tightening credit spreads could dissuade some investors from entire swaths of the bond market, including corporate debt—smart beta or no.

Gary Stringer, president and CIO of Stringer Asset Management, is one such investor. His firm used to hold the PowerShares Fundamental Investment Grade Corporate Bond ETF (PFIG), but it sold it in 2016. Currently, it owns no smart-beta bond funds.

“We focus heavily on relative value in fixed income,” he said. “So we’ll likely buy [PFIG] back eventually … when it becomes more attractive from a risk/reward standpoint.”

Instead of alternative strategy, Stringer and Presti both point to nontraditional fixed-income sectors as a source of value. Stringer likes convertible bonds, nonagency MBSs and preferreds. Presti likes consumer credit and reinsurance.

One thing’s clear, says Presti: “You’re just not going to get value out of AGG anymore.”

 

 

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