Inverted Yield Curve is Forcing Innovation in Bond Market

Treasury yields continued their free fall, which is spooking investors with an inverted yield curve–a recession indicator. As such, it’s forcing bond investors to take a closer look at smart beta when it comes to yield-hunting in fixed income markets, but also creating innovation in the bond markets.

French Asset Manager Ossiam issued its Ossiam US Steepener UCITS ETF on August 19th at Deutsche Börse Xetra, tracking the Solactive US Treasury Yield Curve Steepener 2-5 vs 10-30 Index. The strategy of the Solactive US Treasury Yield Curve Steepener 2-5 vs 10-30 Index consists of a long/short strategy, which places a long position in two-year and five-year US Treasury bond futures and a short position in ten-year and thirty-year US Treasury bond futures.

To harvest further performance from the movement of the US Treasury yield curve, Solactive equips the index with a multiplier leveraging on both directions the action of the yield curve by a factor of ten.

“This is a timely launch of this ETF, considering the yield curve is at its flattest for over a decade. Depending on how the Fed’s interest rate decision plays out compared to market expectations, optimistic investors could generate returns for their fixed income portfolio and place strategic positions”, said Timo Pfeiffer, Head of Research at Solactive. “The ETF provides investors with another tool to play the yield curve and position themselves for a steepening curve play.”

The default maneuver in today’s volatile markets is seeking safe-haven assets, such as bonds. Investors looking to gain broad-based exposure to bonds can look at funds like the ProShares S&P 500 Bond ETF (NYSEArca: SPXB). The fund seeks investment results that track the performance of the S&P 500®/MarketAxess Investment Grade Corporate Bond Index, which consists exclusively of investment grade bonds issued by companies in the S&P 500.

However, investors can also get the smart beta strategies via fixed-income ETFs. The Invesco Multi-Factor Defensive Core Fixed Income ETF (CBOE: IMFD) and the Invesco Multi-Factor Income ETF (CBOE: IMFI) are recent additions to the issuer’s lineup of multi-factor bond ETFs. Both new ETFs track in-house indexes.

IMFI follows the Invesco Multi-Factor Income Index. That benchmark “is designed to provide multi-factor exposure to fixed income securities in the following weights: 25% in mortgage-backed securities, 25% higher-quality US investment grade, 25% high yield, and 25% emerging markets debt,” according to Invesco.

Each of the bond market segments represented in the new ETF has its own criteria for assessing quality and value traits, the factors emphasized by the new ETFs. Last year, Invesco also introduced eight multi-factor bond ETFs that focus on favorable value and quality characteristics.

With outside factors like trade wars seeping into the bond markets, the need for more smart beta exposure simply makes sense.

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