Many fixed-income investors widely track the Bloomberg Barclays U.S. Aggregate Bond Index, but tracking the so-called Agg may open investors to certain risks.
Alternatively, there is a growing group of smart beta bond ETFs that could limit potential risks and help generate enhanced returns.
“If you look at how the Agg evolved over time, it is much different than it was – look at the debt issues of the U.S. government has increased its weight of U.S. treasuries in the Agg, which people may not be aware of,” Salvatore Bruno, Managing Director and Chief Investment Officer with IndexIQ, said at the recent Morningstar ETF Conference. “We think it is important to think about what is exactly in your fixed income and realize that not one-size fits all.”
Different investors have varying levels of risk tolerance. Consequently, one fixed-income investor may be more risk tolerant and favor more credit exposure and higher yields, whereas a more conservative investor would lean toward the safety of highly rated government debt.
Consequently, money managers have come out with alternative indexing methodologies that eschew traditional market cap-weighting to also help fixed-income investors potentially enhance returns and diversify risk, similar to what smart beta ETFs have done for equity investors.
“Looking at how factors worked in the equity world, we tried to port them over to the fixed-income world,” Bruno said. “Momentum is a strategy that has worked well historically not only in equities but also in commodities, currencies and other asset classes. So really just taking that body of research that already existed in equities and trying to apply it to different sectors – say the Agg.”
For instance, IndexIQ has a handful of smart beta bond ETF options for investors to choose from, including IQ S&P High Yield Low Volatility Bond ETF (NYSEArca: HYLV), a rules-based fixed income ETF that specifically tries to target lower volatility exposure in high yield debt, along with the IQ Enhanced Core Bond U.S. ETF (NYSEArca: AGGE) and IQ Enhanced Core Plus Bond U.S. ETF (NYSEArca: AGGP), which incorporate momentum factors to direct investors toward strengthening fixed-income segments in an attempt to enhance returns.
AGGE and AGGP’s momentum following strategy may allow investors to following a trend following style that has resulted in overperformance in the long-term as opposed to a contrarian investor betting on a reversal of recent trends. Meanwhile, HYLV could help investors gain exposure to high-yield debt securities while limiting risk exposure associated with speculative-grade debt securities.
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