With Bonds, Smart Beta Factors Are More Important Than You Think

When it comes to fixed income market veterans, some may think that smart beta factors have no place in this space. However, a study performed by asset manager Robeco found that factors like value and momentum are driving higher returns in fixed income portfolios.

Specifically, factors like value, momentum and low risk were applied to selecting government bonds. According to an article in Institutional Investor, all three factors “generated higher risk-adjusted returns than the market.”

What’s preventing the use of factors from getting more attention in the fixed income arena? All signs point to the lack of data.

“One of the reasons why credit is more difficult for academic researchers and for our peers is they didn’t have access to data,” said Patrick Houweling, lead portfolio manager and researcher of quant credits at Robeco. “Look at academic journals; they have been dominated by research on stocks. But [fixed income]is coming now.”

“The starting point is how people behave in financial markets,” Houweling added. “Even though there is more data in equity markets, it doesn’t mean these patterns only exist in equities. The well-known factors may not use the exact metrics as equities, of course, but they capture the concepts.”

Get Smart (Beta) with these Fixed Income ETFs

One of the challenging aspects advisors face with this more cautious investor is the plethora of options available, especially in the ETF space. Where are the opportunities in ETFs given the current market landscape challenged by obstacles such as trade war fears?

One default maneuver is seeking safe-haven assets, such as bonds. However, investors can also get the smart beta strategies Draper speaks of 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.

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