What Is Smart Beta In Fixed Income ETFs?

May 26, 2017

Hougan: Who’s chasing those higher-volatility bonds?

Bruno: Investors looking for higher yields. We saw that coming out of 2016 in February when credit spreads had blown out to 800-850 basis points over the comparable Treasury. Folks started chasing those yields, and you ended up with a spread over Treasuries of somewhere around 300-320 basis points, close to the all-time lows.

Those who rode the curve did well, but when that situation started to reverse itself and spreads widened out again, the higher-vol names suffered, and those employing a low-volatility approach benefited.

Hougan: Have these ideas been present in the hedge fund universe or the active bond universe, or is this a new academic insight?

Bruno: There was a paper in 2013 that came out and talked about “Value and Momentum Everywhere” that touched on using momentum in fixed income, and another paper that came out in 2015 that looked at using momentum in the Treasury market.

Our unique insight was how we constructed the momentum signal, how we put it together in a disciplined, rules-based process, and then how we used other ETFs to get exposure and overcome the liquidity barrier.

Hougan: At the tail end of a 35-year bull market, what should investors do with the bond portion of their portfolio? Should they continue to hold bonds?

Bruno: We think it’s important to continue to hold bonds in a portfolio … but how you get that exposure could be very important. Our fixed-income momentum ETFs—the IQ Enhanced Core Bond U.S. ETF (AGGE) and the IQ Enhanced Core Plus Bond U.S. ETF (AGGP)—are meant to be replacements for the core aggregate position of a portfolio.

They aren’t unconstrained bond funds, so we have risk-control limits and tracking error targets, and the same thing is true on our high-yield ETF, the IQ S&P High Yield Low Volatility Bond ETF (HYLV). We’re trying to create a way for investors to maintain core exposure to the market while lowering the volatility of their overall portfolio.

 

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