Factor-based ETFs have become popular tools for equity investors to enhance their portfolios, but the same can’t be said for smart beta bond ETFs. Nevertheless, some are beginning to look into these alternative index-based bond strategies.
There are about 56 enhanced index-based bond ETFs with just $7.2 billion in assets under management, according to ETFdb data.
More investors, though, are beginning to invest in factor-based fixed-income strategies, especially in Europe, David Stevenson reports for the Financial Times.
According to an Edhec-Risk Institute survey, Europe institutional investor exposure to government bonds rose from 13% to 66% between 2006 and 2019, while corporate bonds increased from 6% to 68% in the same period. Furthermore, about three-fifths of the institutions surveyed focused on three factors integral to the credit risk market, including carry-to-level of the yield curve, credit, and slope of the yield curve.
Candidate Corporate Bond
“Fixed income factorization… has piqued [our interest]both from a product development and potential use standpoint,” Drew Pettit and Scott Chronert, analysts at Citigroup, said in a note.
Some observers believed that corporate bonds could be a likely candidate for smart beta fixed-income issuers since the instruments share many of the same issues relating to beta, including illiquidity, sector strength and regional focus. BlackRock, though, suggested that fixed income products might be better off with factors that power macro risks, such as real rates, inflation, credit, sovereign credit risk, and liquidity.
If these macro factors are incorporated into a factor strategy, some studies indicated that as much as 80% to 90% of the alpha outperformance from active bond fund managers could be explained away or replicated in a rules-based indexing methodology.
As more consider a factor-based fixed-income approach, most studies suggest that institutions could utilize these types of bond ETFs as tactical trading tools. Meanwhile, retail investors and advisors may look to smart beta bond ETFs for yield enhancement.
Currently, Edhec argued that smart beta bond ETF “usage is limited because the current offer does not correspond to their [institutional investors’]needs in terms of risk factor, and due to a lack of research in the area.”
For more information on the fixed-income market, visit our bond ETFs category.