Bond ETF Strategies to Help Enhance Your Core Fixed-Income Portfolio

Investors can turn to innovative systematic bond exchange traded fund strategies, like those practiced by Dimensional, to help navigate today’s fixed-income market environment.

In the recent webcast, Dimensional Presents Bond Strategies Built for Volatility, Gerard O’Reilly, Co-Chief Executive, Officer, and Chief Investment Officer of Dimensional Fund Advisors, pointed out that while the current market conditions have been disappointing for the traditional 60/40 stock and bond investment portfolio, they are not unprecedented. For example, the 60/40 suffered through losses of more than -10% in January 2020 and December 2010 in recent memory. Looking back to 1926, the 60/40 portfolio on average took 22 months until it fully recovered from such losses of more than -10%.

On a more positive note, after a 60/40 suffered a loss of more than -10% since 1926, the portfolio posted an average return of 7.9% in the following 12 months, 17.54% in the next 3 years and 37.1% in the next five years, O’Reilly added.

Despite the recent volatility, O’Reilly argued that fixed-income assets can play many roles in a diversified portfolio, including capital preservation, volatility management, total return, inflation protection, tax sensitivity, and liability driven investing.

For example, O’Reilly highlighted Dimensional Fund Advisors’ suite of fixed-income ETF strategies, including the Dimensional Short-Duration Fixed Income ETF (DFSD), the Dimensional Core Fixed Income ETF (DFCF), the Dimensional National Municipal Bond ETF (DFNM), the Dimensional Inflation-Protected Securities ETF (DFIP) and the more recently launched Dimensional Global Sustainability Fixed Income ETF (NYSE Arca: DFSB).

O’Reilly explained that Dimensonal’s approach to systematic fixed income is based on market prices, increased expected returns each day, and continuous risk management. Market prices reflect the aggregate expectations of market participants and provide real-time information about differences in expected bond returns. Dimensional uses information in market prices to systematically position portfolios to focus on higher expected returns. They also manage risk through transparent controls in portfolio design and credit monitoring informed by real-time market-based sources.

O’Reilly added that DImensional’s systematic process identifies bonds with higher implied risk than their rating may indicate and proactively manages credit risk for portfolios.

On a day-to-day basis, O’Reilly explained that Dimensional identifies segments with the highest expected return and portfolio capacity to increase or decrease weights. They screen bonds with desired characteristics to identify potential bond trade candidates that meet the portfolio objective. Lastly, the managers maintain flexibility to prioritize price by treating bonds in order sets as close substitutes that each can improve the portfolio.

The company also implements efficient rebalancing in its suite of ETFs to improve expected returns each day, reduce total transaction costs from trading and spreads, and support demand for ETF share creation or redemption.

“Dimensional’s flexible approach to fixed income investing enables innovative and efficient basket execution” O’Reilly said.

Financial advisors who are interested in learning more about the bond strategies can watch the webcast here on demand.