Smart Beta In Fixed Income ETFs Slowly Takes Root

December 22, 2016

iShares JP Morgan USD Emerging Markets Bond ETF (EMB), $7.9 billion in AUM

EMB tracks an index of U.S.-dollar-denominated emerging market sovereign debt. The bonds must have more than $1 billion outstanding and at least two years remaining in maturity. The strategy implements a tiered weighting methodology, which, according to the fund’s prospectus, “is designed to distribute the weight of each country within the Underlying Index by limiting the weights of countries with higher debt outstanding and reallocating this excess to countries with lower debt outstanding.”

The fund tends to favor longer maturities than a segment benchmark such as the market-value-weighted Barclays EM Local Currency Government Index, and also “tends to lean toward riskier paper, both of which increase yield,” according to Analytics.

PowerShares Emerging Markets Sovereign Debt Portfolio (PCY), $3.8 billion in AUM

PCY is another dollar-denominated emerging market bond fund holding debt with at least three years to maturity. The fund employs a tiered weighting scheme in a portfolio that also takes into account liquidity and relative value.

Both EMB and PCY have underperformed a traditional vanilla take on the segment this year, such as the Vanguard Emerging Markets Government Bond Index Fund (VWOB). Note that EMB costs a net of 0.40% after a 0.20% fee waiver, while PCY charges a 0.50% expense ratio. VWOB is the cheapest, at 0.34%: 

FlexShares iBoxx 3 Year Target Duration TIPS Index Fund (TDTT), $1.8 billion in AUM

TDTT tracks an index of inflation-protected U.S. government debt with maturity of anywhere from 1-10 years. The fund uses a proprietary weighting scheme, and strives for weighted average portfolio duration of three years, which means shorter maturity and duration than a comparable segment benchmark such as the Bloomberg Barclays 1-10 Year U.S. Government Inflation-Linked Bond Index. TDTT also tends to have lower nominal yield, according to Analytics.

Compared with SPDR Bloomberg Barclays 1-10 Year TIPS ETF (TIPX), which selects and weights bonds by market value, TDTT has also underperformed in 2016. TDTT is also the most costly to own, with a net expense ratio of 0.20% versus 0.15% for TIPX. 


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