Bonds remain an important component of a well diversified investment portfolio, and fixed-income investors can look to ETFs to better adapt to the changing market environment.

“There’s a whole lot of opportunity when it comes to fixed income,” Marc Zeitoun, Head of Strategic Beta, Columbia Threadneedle Investments, said at the Morningstar Investment Conference. “People are understandably nervous about the environment, so they don’t really know where to go. We’re lucky enough to have solutions to give people a resting spot, whether it’s on the tactical side or the tax-free side.”

As a way to help investors gain a smarter exposure to the fixed-income market and diversify away from the shortcomings of a market cap-weighted bond index, Columbia Threadneedle offers the Columbia Diversified Fixed Income Allocation ETF (NYSEArca: DIAL), which follows an alternative indexing methodology.

The bond ETF tries to reflect the performance of the Beta Advantage Multi-Sector Bond Index, a rules-based multi-sector strategic approach to debt market investing. The underlying smart beta index covers six sectors of the debt market, focusing on yield, quality and liquidity.

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By achieving its goal of yield enhancement, DIAL includes multiple sectors throughout the US and around the globe; excludes short term government with limited yield; excludes non-government with limited risk premium; and exclude negative yielding bonds.

The ETF’s quality management aims to avoid the “tails of the market” by removing sectors that offer no risk premium and lower quality tiers that have outsized downside risk, which essentially means no corporates rated below single-B ratings, no sovereigns rated below double-B ratings and no corporates longer than 15 year maturity.

Additionally, the fund keeps in mind liquidity limitations or focuses on issues with sufficient tradability to provide investors with liquidity, managed against volatility. The index screens for larger issue size, screens for recently issued securities and limits number of bonds per issuer.

Additionally, the Columbia Multi-Sector Municipal Income ETF (NYSEArca: MUST) is one way for investors to broaden their opportunity set and gain exposure to a more effective tool to implement a passive muni solution. MUST could help complement a traditional approach to municipal bond investing and improve investor outcomes. The smart beta methodology leans toward potential opportunity as opposed to traditional market cap-weighting or indebtedness. As a result, the portfolio takes a more active approach to enhance yield and generate improved risk-adjusted returns over conventional municipal benchmarks while following a passive, rules-based indexing methodology.

The underlying portfolio includes a 25% tilt toward shorter, high quality muni debt securities, which provides stability and buoys lower-rated, higher yielding bonds; 45% toward all-weather core positions, which balance duration and credit risk by targeting lower-rated investment grade and intermediate-term revenue bonds; and 30% in longer, low quality debt, which pursues a higher level of income via credit risk in an attempt to mitigate interest rate sensitivity.

Watch the full interview between ETF Trends CEO Tom Lydon and Marc Zeitoun:

For more ETF-related commentary from Tom Lydon and other industry experts, visit our video category.

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