What Is Smart Beta In Fixed Income ETFs?

May 26, 2017

Hougan: One thing that’s true of any smart-beta strategy is that it won’t beat the market every day. In what kind of markets will these strategies underperform, and what should investors do about that?

Bruno: That depends on what sort of factor you’re looking at.

Clearly, in momentum-based strategies, when you’re in choppy markets, those will have a hard time, because you’re trying to pick up on a strong trend. One of the things we’ve tried to do is take a disciplined, rules-based approach to targeted tracking error. That way, even if the market isn’t working for you, you’re not taking exorbitant risks.

In something like low volatility, if you’re in a risk-on trade, a lower-vol offering will probably underperform. If credit spreads go from 8% to 3%, for instance, that’s an environment where low vol will underperform.

But when you get that reverse move and you move back from 3% to 6% or 8%, you’d expect lower vol to outperform. Because there are asymmetries in the returns—if something goes down a certain amount, it has to go up a lot more to get back to breakeven—that’s where we think using some of these products over the full cycle can really be beneficial.

Hougan: Any last thoughts?

Bruno: We’re looking at an environment where rates are more likely to rise than they are to fall, and spreads are more likely to widen than they are to come back down. We think it’s a really interesting and opportune time … for advisors to take a look at these strategies and think about how they might want to use them in a portfolio.

 

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