As the world’s debt balloons to a size that is larger now than at the height of the global financial crisis, bond ETF investors are forced to consider alternative strategies to manage risks in the face of central banks’ rising interests rates and unwinding quantitative easing programs.
“Conditions are changing in fixed income markets,” Dan Draper, Invesco’s head of exchange traded funds, told the Financial Times. “The interest rate on US 10-year bond has reached 3 per cent and the yield curve has flattened so there is a real appetite for building blocks that provide better risk diversification.”
Smart beta as an alternative to traditional market capitalization-weighted indexing methodologies is gaining traction to help investors steer away from more indebted government or corporate issuers.
“If a country continues to issue more and more debt, does that justify a higher allocation by investors? Addressing this issue is very important,” Yazann Romahi, chief investment officer for quantitative beta strategies at JPMorgan Asset Management, told the Financial Times. “The risk dimension in smart beta is just as important as the return dimension but it is often overlooked.”
Traditional market cap-weighted bond funds would weight holdings based on indebtedness, so issuers with more debt have a larger weight.
“We have seen interest from income-hungry investors looking for slightly more risky strategies, but also on the defensive side with clients looking for qualitative measures to weight debt issuers, instead of just allocating to the most indebted sovereign or company,” Vincent Denoiseux, head of portfolio solutions at DWS, told the Financial Times
Nevertheless, the uptake for smart beta bond ETFs remains slow. Felix Goltz, research director at Edhec-Risk, argued that investors are concerned that methods developed for the application of smart beta in equity strategies may not translate into fixed income.
For more information on the fixed-income market, visit our bond ETFs category.