Investors often believe they can’t have their cake and eat it too when it comes to fixed income ETFs, meaning they’re either taking on credit risk or interest rate risk. The iShares Edge U.S. Fixed Income Balanced Risk ETF (CBOE: FIBR) provides a balancing act between those two sources of bond risk.

Previously an actively managed fund, FIBR follows the Bloomberg Barclays U.S. Fixed Income Balanced Risk Index and holds 817 bonds. That index is “composed of taxable U.S. dollar-denominated bonds and U.S. Treasury futures, which targets an equal allocation between interest rate and credit spread risk,” according to iShares.

FIBR may also adjust holdings to achieve a target credit spread risk and interest rate risk for the portfolio. For instance, the fund can take short or long positions in U.S. Treasury futures and short positions in U.S. Treasury securities through interest rate swaps, along with other interest rate futures contracts, like Eurodollar and Federal Funds futures.

“This strategy sizes its sector allocations so they each contribute an equal amount of estimated risk to the portfolio,” said Morningstar in a recent note. “This is an important departure from traditional portfolio construction, where diversification is often measured by the dollar value invested in each position and sector. The trouble with this approach is more-volatile positions account for a disproportionate share of a portfolio’s risk, so the dollar allocations may not paint an accurate picture of where a portfolio’s risk is coming from.”

Put Some FIBR In Your Bond Diet

As investors consider ways to adapt to a changing interest rate environment, a new breed of smart beta fixed-income ETF strategies may help limit risks.

Traditional bond ETFs may expose fixed-income investors to risks in a rising interest rate environment. For instance, many follow a market capitalization-weight methodology that would overweight the most indebted issuers. Furthermore, they target a specific range of maturities that could leave investors negatively exposed to changes in interest rates.

FIBR “sizes its positions to target an equal contribution of risk from each of the five credit sectors it includes, subject to minimum monthly volatility of 1% (standard deviation) in each sector. So, more-volatile sectors like high-yield bonds receive lower dollar weightings in the portfolio. This approach effectively diversifies sector risk,” according to Morningstar.

FIBR has an effective duration of 2.61 years.

For more information on the fixed-income space, visit our bond ETFs category.

The opinions and forecasts expressed herein are solely those of Tom Lydon, and may not actually come to pass. Information on this site should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product.

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