Most fixed income investors have exposure to a market cap-weighted bond index, which may expose people to unexpected risks, especially in a rising rate environment ahead.
Alternatively, investors can look to a smart beta bond exchange traded fund strategy that follows a rules-based indexing methodology.
On the recent webcast (available on-demand), An Investment Grade ETF Strategy for Diversifying Income, Kevin DiSano, Managing Director and Head of ETF Sales at Nuveen, pointed out that many core bond investors today have seen yields fall off but don’t want to assume the greater risk associated with higher yielding segments and may be unwittingly exposed to greater interest rate and concentration risk.
The need for income is not going away, but investors are suffering from a low-yield environment. Specifically, the baby boomer generation is entering the retirement years, and many are living longer with life expectancy rising, are leading healthier lives with an overall decline in those reporting poor health and are more in debt with more continuing to incur mortgage payments even in retirement.
Most investors look to the benchmark Barclays U.S. Aggregate Bond Index as their guide to fixed-income investments. However, the index follows a market cap-weighted methodology, so issuers with the most debt have a higher weighting. Consequently, the Barclays Agg has increased its exposure to U.S. Treasuries over the past decade, which leaves the benchmark index exposed to greater interest rate risks, with a higher duration and lower yields.
Alternatively, DiSano argued that a strategic or smart beta approach may address concerns of a traditional market cap-weighted methodology.[related_stories]
Strategic beta ETFs are “designed to provide better risk/return profiles than market cap weighted benchmarks by assigning weights according to factors other than market cap,” DiSano said.