“Such a strategy could address the investment universe screened by yield, quality and liquidity,” Kerschner said. “Investors seeking higher returns could be well-served to move out along the risk-reward profile.”
For example, Kerschner pointed to other sectors that are not traditional found in the Agg, such as high-yield, global Treasuries or emerging marekt debt, which exhibit lower cross-correlations that help diversify a portfolio and potentially enhance yield generation.
“Moving out along that risk-reward profile finds opportunities that are both less correlated and have historically offer relatively high returns,” Kerschner said.
As we move out of the comfort zone of low-yielding but safer U.S. government, investors will be exposed to potentially greater risk in higher yielding debt. Nevertheless, Gene Tannuzzo, Senior Portfolio Manager of Strategic Income for Columbia Threadneedle Investments, pointed out that a smart beta or alternative index-based ETF strategy, like Columbia Diversified Fixed Income Allocation ETF (NYSEArca: DIAL), can manage yield, quality and liquidity through a transparent rules-based process.
A rules-based or smart beta ETF can screen for specific factors to find the right balance between yield, quality and liquidity. For example, yield enhance can exclude short-term government debt with limited yield, non-government with limited risk premium and negative yielding bonds. The quality screen would exclude those corporate debt rated below single B, rated below double-B and longer than 15 year maturity that have greater downside risk. Lastly, a liquidity screen that looks for larger issue size, recently issued securities and a limit on bonds per issuer can help provide investors with greater liquidity to manage against volatility.
DIAL’s underlying index tries to target six sectors, including U.S. Treasury securities (10%); global ex-U.S. treasury securities (10%); U.S. agency mortgage-backed securities (15%); U.S. corporate investment grade bonds (15%); U.S. corporate high yield bonds (30%); and emerging markets sovereign and quasi-sovereign debt (20%). Each sector is market value-weighted except for the global ex-U.S. Treasury Securities, which is equally weighted.
“A market cap-weighted international treasury index, such as the World Government Bond Index, has a disproportionate exposure in a small number of countries, notably a concentration in Japan. The result is an index that has a high concentration, low yield and long duration. The Beta Advantage Multi-Sector Bond Index methodology provides a more diversified country and currency exposure, investing in higher yielding countries, and a modestly shorter duration,” Tannuzzo said.
Financial advisors who are interested in learning more about alternative fixed-income strategies can watch the webcast here on demand.