Smart Beta Looks to Make Inroads With Bond ETFs

When it comes to smart beta exchange traded funds, many investors initially think of equity funds. However, ETF issuers are upping the smart beta ante in the fixed income universe, too.

The PowerShares Emerging Markets Sovereign Debt Portfolio (NYSEArca: PCY) is one of the oldest and largest smart beta bond ETFs. PCY tries to reflect the performance of the DB Emerging Market USD Liquid Balanced Index, which tracks U.S. dollar-denominated government bonds issued by 22 developing economies.

However, the smart beta bond universe is growing, giving investors more opportunities to explore the potential of fundamental weighting with bonds.

“Relatively speaking, this is still a new frontier. Like their equity brethren, smart-beta bond ETFs employ factors other than market capitalization; in the case of fixed income, the criteria for weighting include credit quality, yield, and volatility,” reports Lewis Braham for Barron’s.

New smart beta bond ETFs include the FlexShares Core Select Bond Fund (NYSEArca: BNDC), which debuted in the fourth quarter.

The new fund will try to provide attractive risk-adjusted performance by investing in a portfolio of fixed-income securities and is designed to achieve optimal potential for return, according to the prospectus. Moreover, the active component will adjust to potential changes in interest rate levels, the shape of the yield curve and credit spread relationships while emphasizing liquidity and diversification.

As the ETF manages its exposure to interest-rate risks, the fund managers may take short or long positions in U.S. Treasury futures or transact in interest rate swaps, along with interest rate futures contracts.