Can Smart Beta Bond ETFs Gain Traction?

January 04, 2016

The Hazy Future of Smart-Beta Bond ETFs
Some newer bond ETFs try to optimize both duration and creditworthiness at the same time. For example, the $413 million Vident Core U.S. Bond Strategy ETF (VBND | C) selects and weights U.S. bonds by sector tail risk, security valuation and corporate governance.

But it remains to be seen whether these combo funds, or any smart-beta bond ETFs, will catch on with investors.

A persistent lack of liquidity may be preventing wider use of smart-beta bond ETFs, says Ladner, whose firm has used PHB in the past. “Liquidity is a large concern for us,” he said. “An ETF must have a certain asset size and trading volume before we can even consider it, and there aren’t a lot of fixed-income smart-beta ETFs that pass that test right now. Plus, the market makers really aren’t on board yet for these alternative weighting schemes.”

It’s the classic chicken-or-the-egg scenario: Smart-beta bond ETFs need a wider presence to catch on with investors, but they can’t gain that presence without investors first using them. And that’s stymying growth: No new smart-beta bond ETFs were filed or launched in 2015, although in February, iShares did introduce a “technically active” bond ETF, the U.S. Fixed Income Balanced Risk ETF (INC | C).

Still, the potential is there. Convincing investors may simply require more research, says Ladner.

“If you don’t have any expectation about how something will perform, it’s very difficult to use it in a portfolio setting,” he said.

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