Targeted Bond ETFs Can Help Investors Navigate Changing Market Conditions

ETF investors should consider what makes smart beta investments tick and look at how factors can work in a fixed-income portfolio to better help diversify their bond exposure.

On the recent webcast, Building Blocks for Your Fixed Income Portfolios, Diana Sands, Vice President, US and Global Fixed Income for Goldman Sachs Asset Management, outlined the general trends with continued economic growth, albeit at a slower pace, and relatively stable inflation just below trend. Looking ahead, the Federal Reserve may ease its monetary policy amid trade-related growth concerns.

Steve Sachs, Head of Capital Markets, ETFs, at Goldman Sachs Asset Management, highlighted the ongoing growth in the fixed-income segment of the ETF universe. Fixed-income ETF assets under management has more or less doubled about every 3 years since the category’s inception and now sits at above $700 billion as the industry moves away from traditional market value-weighted benchmarks to more targeted or sector-specific exposures, along with the emergence of intelligent market exposures through smart beta bond strategies.

While bond ETFs share similarities with stock ETFs, investors should be aware of the differences. Sachs pointed out that while both equity and fixed income indices were initially used as measurement tools, fixed income indices also provided the market with inventory levels of major dealers. Moreover, since bonds don’t trade on open exchanges and prices are not made public, fixed income data is more difficult to acquire. The debt market is not as liquid as the equity market, with 99.8% of U.S. equities trading every day, compared to the less than 20% of all bonds trading each day and roughly 10% of all corporate bonds trading each day.

Consequently, “we believe holding every security in a fixed income index is inefficient given the nature of the bond market,” Sachs said.

Sachs pointed out that given the illiquid nature of the fixed income market, the market price of a bond ETF may be a better approximation of the aggregate value of an ETF’s underlying bonds or help with price discovery. ETFs allow investors to observe the impact of new information on fixed income markets in a more timely fashion through the intra-day market price.

Most bond ETFs would also employ optimization whereby a Portfolio Manager constructs a portfolio with the goal of tracking the underlying index to the best of their ability while balancing liquidity, transaction costs and overall tax efficiency. Since the portfolios of bond ETFs are sampled, PMs have greater flexibility in buying or selling individual debt securities.

Additionally, since an ETF represents hundreds of bonds in a single security that trades on-exchange, ETF investors may reduce trading costs compared to the complexities of trading individual bonds over-the-counter in the less liquid primary markets, especially in the notoriously illiquid high-yield category.

When looking at their similarities to equity ETFs, fixed income ETFs enjoy the lower total cost, tax efficiency, transparency and ease of trading associated with the ETF investment vehicle.

“We believe fixed income ETFs are evolving and are poised for continued growth. Their attractive liquidity profile, ease of use and cost effectiveness are transforming access to the fixed income markets. Potential benefits of the ETF structure, such as price discovery and insulation from the activities of other shareholders, may play a valuable role in navigating changing fixed income markets,” Sachs added.

As a way to help ETF investors better access the fixed-income markets, Goldman Sachs offers a range of bond strategies, including Goldman Sachs Treasury Access 0-1 Year ETF (NYSEArca: GBIL) and Goldman Sachs Access Inflation Protected USD Bond ETF (Cboe: GTIP) as part of the rate markets strategy, along with the Goldman Sachs Access Investment Grade Corporate Bond ETF (NYSEArca: GIGB), Goldman Sachs Access High Yield Corporate Bond ETF (GHYB) and Goldman Sachs Access Ultra Short Bond ETF (GSST) as part of their credit markets offering.

The two rate market strategies screen underlying holdings based on technical indicators and remove securities that fail the screen. Meanwhile, the three credit market strategies take on screens to sift through fundamental indicators, removing the bottom ranking bonds.

Financial advisors who are interested in learning more about fixed-income investment strategies can watch the webcast here on demand.