Many smart beta exchange traded fund strategies have found their way into investors’ portfolios but few have been incorporated into fixed-income positions. Nevertheless, the industry is now expanding upon their smart beta offerings to include factor-based bond ETFs to help investors diversify and potentially enhance their portfolios.
For example, the IQ Enhanced Core Plus Bond U.S. ETF (NYSEArca: AGGP) recently passed their 1-year mark after launching on May 10, 2016, and it has outperformed the benchmark Bloomberg U.S. Aggregate Bond Index over the past year and year-to-date.
Investors have also been taken with the smart beta bond ETF strategies, funneling over $240 million into AGGP, making the alternative index-based fixed-income ETF among the most successful new launches over the past year.
Helping the strategy outperform the broader benchmarks, AGGP incorporates momentum factors to direct investors toward strengthening fixed-income segments in an attempt to enhance returns. The ETF adheres to a momentum investing strategy where momentum is measured by comparing a short-horizon, 45-day moving average of returns to longer-horizon, 90-day moving average of returns while taking into account recent volatility in each sector. The underlying factor-based index also weighs each of the fixed-income sectors based on the total return momentum of each sector.
“Momentum-style investing can be applied to fixed income through a dynamic sector allocation strategy using major sector building blocks of the Barclays Agg Index,” according to an IndexIQ research note. “Using a volatility-adjusted crossover signal for the momentum score calculation allows the strategy to compare different sectors on the same basis and avoid fake signals from erratic short-term moves.”
The momentum bond investment strategy may help enhance returns. IndexIQ research has revealed that over the period between January 2004 to July 2016, the momentum plus strategy outperformed the AGG by 141 basis points per year.
The smart beta bond ETF could also help investors weather the storm in a rising rate environment and in other periods of greater volatility within the broader fixed-income markets. The strategy outperformed the Barclays Agg Index during rising rate periods from June 2004 through July 2006, the Barclays Agg Index max drawdown period from April through October 2008, and the so-called taper tantrum of 2013.
Moreover, AGGP, like its name suggests, provides access to core positions “plus” up to 25% in U.S. high yield debt and up to 5% in U.S. dollar denominated debt of emerging market issuers to potentially help investors enhance returns, and so far, this plus position has helped the strategy outperform traditional benchmarks.
AGGP acts as a fund of funds, including bond ETFs that have exhibited strong forward momentum. The smart beta bond ETF’s top holdings include the Vanguard Intermediate-Term Corporate Bond ETF (NYSEArca: VCIT) 15.6%, Vanguard Mortgage-Backed Securities Index ETF (NYSEArca: VMBS) 14.2% and iShares iBoxx $ Investment Grade Corporate Bond ETF (NYSEArca: LQD) 14.0%.
The smart beta bond ETF comes with a 5.31 year duration, a 3.19% 30-day SEC yield and a relatively cheap 0.35% expense ratio.