Nuveen’s New ETF Take On The Barclays Agg

Nuveen is the latest investment manager to enter the ETF space, with the launch of a fixed-income ETF designed to improve on a classic: the Barclays Aggregate.

The NuShares Enhanced Yield U.S. Aggregate Bond ETF (NUAG), tracking the BofA Merrill Lynch Enhanced Yield US Broad Bond Index, offers investors additional yield without much additional risk. The fund costs 0.20% in expense ratio.

To Nuveen, which manages nearly $240 billion in assets, NUAG is just the first ETF in a lineup the firm plans to bring out in the next few years. Martin Kremenstein, head of ETFs for Nuveen, tells us what’s driving the company’s efforts.

ETF.com: Your first ETF is an index-based enhanced yield ETF. Is this strategy meant to be a better take, or a higher-yielding take, on the Barclays Agg?

Martin Kremenstein: Yes, it's meant to be a core fixed-income replacement. It’s basically breaking the link between issuance weighting and the weighting in your portfolio. So rather than weight by issuance, what we do is start off with the Merrill Lynch Broad Market Index, which is basically equivalent to the Barclays Agg, and then, through a series of control of the risk parameters, we overweight higher-yielding sectors.

We divide up the aggregate universe into 38 sectors by maturity, and by underlying asset class, like Treasurys, corporates, securitized debt, and then, within those maturities and asset classes, by credit rating.

The idea is that you take the highest-yielding subsector and you overweight it within a certain limit, and then you underweight the same amount in the lowest-yielding sector. We’re creating a very-risk-controlled way of enhancing yield. Our quant research team identified that, within the aggregate universe, yield is the biggest driver of returns for investment-grade investors. Therefore, you should be overweighting toward yield to try and generate the best outcome.

We keep the option-adjusted duration of the portfolio within a quarter of the year of the underlying broad market index. And we keep the key rate risk the same as well. You can basically keep duration the same, but overweight 10-year and underweight five-year. We keep those key rates the same so that if interest rates rise and if the interest rate curve shape changes, investing in the fund shouldn't be unduly harmed or have outcomes that we're not expecting.

ETF.com: To select which segments are delivering the highest yield, are you looking to the past—at the last 30 days of yield—or are you looking ahead, based on projections? And how often do you revisit these yields to rebalance?

Kremenstein: We rebalance monthly. And we're taking a snapshot of the yield at that point. Because within a sector, yields aren't moving tremendously, and certainly not in comparison to each other. The aggregate investor has a tendency to move very much in line, apart from the little changes along the margins. But the rebalance is also limited to 5% turnover per month, because this ETF is not designed to be a heavily traded portfolio.

To give you an example of what kind of pickup you get, if we took the ETF’s underlying index snapshot as of Aug. 31, the index yield was 2.41% versus the yield of the broad market index, which is the Agg equivalent of 1.9%. So you picked up 51 basis points, but you haven't taken on extra duration, you haven't taken on key rate risk. You've taken on some credit risk, but in a constrained way.

ETF.com: This is your first ETF under the NuShares platform. What about this particular space makes sense right now? Is it a matter of good timing, given the environment in the bond market and interest rates, or is this about a need for innovation in the fixed-income ETF space?

Kremenstein: It comes from a few things. One is, there have been a slew of strategic beta products launched in the equity space, but far, far fewer in the fixed-income space. Really, a lot of that’s driven by the lack of data and a lack of expertise, because equity data is so available and there are lots of different index providers doing all sorts of different things in the smart-beta equity space.

In fixed income, there's much less data available; there's little public data. And even when you have the data, there aren't that many groups able to take advantage of it and make use of it. We're very fortunate within TIAA Global Asset Management to have access to the TIAA fixed-income division, which manages around $250 billion in assets across everything from Treasury to structured products to high yield. TIAA has, in all, some $850 billion in assets under management.

Within that group, there’s a quantitative fixed-income team. They'd actually been looking at building out a smart-beta framework for the aggregate users. And we came on board and were looking at where to build product, and we found there isn't a lot of opportunity for investors to really break that issuance-weighting paradigm within corporate income holdings.

The fact that it's coming out in this market environment, well, I think we're a little bit lucky because it's definitely the right time for a product like this.

ETF.com: Nuveen is primarily an active shop, right? Why bring out a passive ETF, particularly in fixed income, where active management actually does pretty well and has a good following?

Kremenstein: We wanted to do something that was complementary to the product suite. We already have a slew of active strategies available in mutual fund-wrapped investments, so to just provide another active strategy, we really wouldn't be offering anything that additive to our client base. We're not saying we're not doing active in the future, but we felt this strategic-beta product was really the right product for us to be bringing to market now.

ETF.com: Now, Nuveen subadvises funds with State Street. Is that partnership ongoing, or is it coming to an end now that you have your own ETF platform?

Kremenstein: That partnership is still very strong. They've had a very good asset raise this year. Performance has been good. There's no reason to meddle with that. I think there's plenty of space in the rest of the ETF market for us to build a very, very strong business without touching that franchise, which has been very successful.

ETF.com: What’s driving Nuveen to launch its own ETF platform? Is it client demand? Are your mutual fund clients asking for ETFs?

Kremenstein: There's clearly a lot of client demand for ETFs. I think every large asset manager has had to, over the last couple of years, really develop an ETF strategy. And for some of them, their ETF strategy was to not enter the market. But for others, it was.

Large asset managers can no longer ignore the space.

Nuveen realized with their distribution strength and their brand, and then with the resourcing and scale of TIAA now, that this made perfect sense for them—to enter the ETF space, particularly given the strength of the taxable fixed-income business that we can bring in terms of the strategies and portfolio management from the TIAA side.

ETF.com: For ETF investors who don't know that much about Nuveen, how do you characterize what sets Nuveen apart as a wealth manager?

Kremenstein: We have a very strong fixed-income franchise, especially given the fact that we have the strength and scale of TIAA behind us, and the fact that we’re in the intermediary space. Nuveen is an incredibly trusted brand, particularly in the muni space.

In the ETF market in general, the actual portfolio manager has been less at the forefront—it’s been less important who was managing your equity ETF or whatever—because it's an index and it's still about the index.

But in the fixed-income space, because you can’t track the index perfectly, you have to optimize, so the scale and the track record of the manager running it actually does become important. You want to know that they can actually track the index in a way that is as close to the index that you're expecting to buy as possible. We have a very, very good reputation for solid management of investment money.

ETF.com: What's next? Do you have other ETFs in the works? Are you going to focus exclusively on fixed income?

Kremenstein: I can't talk about anything that hasn’t been filed, and I can't talk about anything that’s in filing. But let me tell you that we have many great strategies that we're going to be bringing out over the next 18 months to two years and beyond.

NUAG is a great example of the kind of product we'll be bringing. But there will be some other strategies and some other things we're looking to explore that we think are relevant and timely for investors today.

Contact Cinthia Murphy at [email protected]