Many have looked into smart beta exchange traded funds to enhance returns and diminish risks in their equity market exposure, but smart beta bond ETFs are still finding their feet. Nevertheless, two fixed-income options have just recently celebrated a strong year.
The IQ S&P High Yield Low Volatility Bond ETF (NYSEArca: HYLV), IQ Enhanced Core Bond U.S. ETF (NYSEArca: AGGE) and IQ Enhanced Core Plus Bond U.S. ETF (NYSEArca: AGGP) recently passed their 1-year mark after launching on May 10, 2016.
AGGP in particular has been a standout over the past year, outperforming the widely observed Bloomberg Barclays US Aggregate Bond Index by over 200 basis points and the broader Intermediate-Term Bond Category by close to 90 basis points.
Investors have also been taken with the smart beta bond ETF strategies, funneling over $235 million into AGGP and a lesser $70 million into AGGE, making the two alternative index-based fixed-income ETFs among the most successful new launches over the past year.
“The emergence of factor-based or ‘strategic beta’ approaches in fixed income ETFs, after their tremendous growth in the equity category, has been one of the major stories in the ETF space over the past year, and IndexIQ has been leading the charge,” Sal Bruno, CIO of IndexIQ, said in a note.
AGGE and AGGP incorporate momentum factors to direct investors toward strengthening fixed-income segments in an attempt to enhance returns. Both ETFs adhere to a momentum investing strategy where momentum is measured by comparing a short-horizon, 45-day moving average of returns to longer-horizon, 90-day moving average of returns while taking into account recent volatility in each sector. Moreover, the underlying indices weigh each of the fixed-income sectors based on the total return momentum of each sector.
“Momentum-style investing can be applied to fixed income through a dynamic sector allocation strategy using major sector building blocks of the Barclays Agg Index,” according to an IndexIQ research note. “Using a volatility-adjusted crossover signal for the momentum score calculation allows the strategy to compare different sectors on the same basis and avoid fake signals from erratic short-term moves.”
The momentum bond investment strategy may help enhance returns. IndexIQ research has revealed that over the period between January 2004 to July 2016, the momentum strategy outperformed the Barclays AGG Index by an average of 109 basis points per year while the momentum plus strategy outperformed the AGG by 141 basis points per year.
AGGE will act as a core bond position, providing exposure to U.S. Treasuries, U.S. investment grade corporate bonds and U.S. investment grade mortgage-backed securities. On the other hand, AGGP, like its name suggests, provides access to core positions similar to AGGE “plus” up to 25% in U.S. high yield debt and up to 5% in U.S. dollar denominated debt of emerging market issuers.
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