The universe of smart beta fixed income exchange traded funds is expanding. Some new products in that space that debuted this year include the iShares Edge Investment Grade Enhanced Bond ETF (Cboe: IGEB) and the iShares Edge High Yield Defensive Bond ETF (Cboe: HYDB).
Those ETFs debuted in July. IGEB, the investment-grade offering, tracks the BlackRock Investment Grade Enhanced Bond Index while HYDB follows the BlackRock High Yield Defensive Bond Index.
The Edge Investment Grade Enhanced Bond ETF tries to reflect the performance of the BlackRock Investment Grade Enhanced Bond Index, which is comprised of investment-grade corporate debt and screens out debt with the highest probability of default and then optimizes to improve risk-adjusted returns by weighting more heavily toward bonds with attractive default-adjusted spreads.
The Edge High Yield Defensive Bond ETF tries to reflect the performance of the BlackRock High Yield Defensive Bond Index, and similar to IGEB, HYDB screens out bonds with the highest probability of default but focuses on high-yield corporate debt.
IGEB and HYDB bring factor-based investing to corporate bond funds, which are typically weighted by issue size.
“Screening on quality can create a portfolio of securities that is generally lower in risk than the broad market, and also lower in yield,” said BlackRock in a recent note. “The quality portfolio may have higher risk-adjusted returns than the broad market, but it will also likely have lower overall returns due to the lower yield. This tradeoff may not be appealing to some investors—the improvement in risk-adjusted returns may not be worth the cost of giving up total return.”
On its own, a value screen also affects bond portfolios.
“Tilting toward value can create a portfolio of high yielding securities relative to the broad market,” according to BlackRock. “However, these higher yielding bonds are often the most risky, resulting in a lower risk-adjusted return than the broad market. The value portfolio could generate higher returns and yields but not without the cost of higher risk.”
IGEB holds 230 bonds and has an effective duration of 7.5 years. HYDB holds 175 high-yield bonds and has an effective duration of 3.94 years.
“Applying a quality screen to the market can remove those securities with the highest expected chance of defaulting, resulting in a higher quality universe of securities from which to build a portfolio. Bonds are then chosen using a value tilt, picking the higher value names after the worst have been removed,” according to BlackRock.
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