Rising Rates Could Trigger Smart Beta Bond ETF Growth

As we brace for the Federal Reserve’s changing monetary policy outlook, investors are beginning to look into alternative ETF strategies with more favorable risk and reward dynamics.

“Investors know that interest rates have to rise from here and there is a real appetite among clients to find more intelligent ways of managing the risks facing their fixed income portfolios,” Nizam Hamid, head of exchange traded fund (ETF) strategy for the European arm of provider WisdomTree, told the Financial Times.

Specifically, more are looking into smart beta as an alternative to traditional bond indices, which tend to follow market capitalization-weighted methodologies that lean more toward indebted government or corporate issuers.

Traditional market cap-weighted bond indices “reward the profligate,” Yazann Romahi, chief investment officer for quantitative beta strategies at JPMorgan Asset Management, told FT. “There is demand from investors for better diversified fixed income indices, but the challenges in building smart beta strategies for bonds are much more nuanced than in equity markets.”

Data issues have impeded the growth of smart beta bond ETFs. Obtaining accurate data on debt securities is problematic as many transactions are private over-the-counter deals, unlike trades on a regulated exchange.