Fixed-income ETF investors should carefully consider the growing risks that many now face and look to a smart alternative that could help generate income while limiting potential downside risks.

On the recent webcast (available On Demand for CE Credit), The Fed, Factor Investing and Fixed Income, Jordan Farris, Managing Director and Head of ETF Product Development at Nushares from Nuveen, outlined the current fixed-income market environment where a Federal Reserve is planning to normalize interest rates with two more rate hikes later this year.

“As the economic cycle advances, the yield curve is starting to flatten, usually a signal that a recession is on the horizon,” Farris said. “Although a recession on the horizon may not necessarily mean it is imminent, investors may want to approach financial markets with caution.”

After enjoying a three-decade long bull run, the fixed-income market environment has greatly changed. U.S. Treasury debt issuance increased by 48% over the past 12 years – Treasuries now make up the major portion of U.S. investment-grade bond market. Since the credit crisis, U.S. investment grade bond yields have declined by about 50% while duration steadily increased. Meanwhile, we are witnessing a large transition of baby boomer investors from working to retiring.

Furthermore, Farris warned that the eight-year bull market and benign credit environment largely masked the risks of increasing equity exposure and relying on a broad U.S. bond market benchmark to meet investment needs.

“Core bond allocation techniques need to become more nuanced,” Farris said.

Factor-Based & Smart Beta Bond ETF Strategies

Alternatively, Farris argued that fixed-income investors may take a look at factor-based or smart beta bond ETF strategies to better manage risk and potentially enhance returns in this changing market environment.

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