While smart beta is the hottest thing in the exchange-traded fund world, bond portfolios have yet to catch on. But BlackRock Inc. doesn’t mind being early to that party.
The world’s biggest money manager listed the iShares Edge High Yield Defensive Bond ETF, symbol HYDB, and an investment grade version of the fixed-income smart beta fund last month, according to data compiled by Bloomberg. Using smart beta strategies, the ETFs eschew traditional selection and weighting methodologies for customized exposures similar to those provided by active managers.
Drawn in by their growing liquidity, tax efficiency and low fees, U.S. investors funnelled a net $70 billion to bond ETFs in the first half of the year, nearly as much as they added in all of 2016, according to data compiled by Bloomberg.
Those flows have largely been confined to market capitalization-weighted funds however, and not to smart beta products, which have proved far stickier with stock investors. Bond buyers continue to have faith in active managers and some remain skeptical of ETFs that use the strategies, said Rob Nestor, head of iShares smart beta at BlackRock.
"It’s very early, but we’re OK with being early," said Nestor. "A lot of the same factors that have become much more widely known in the equity space also play out in the fixed income space. It’s going to come down to education and understanding."
‘Superior Returns’
The new ETFs use alternative weightings to chase "superior risk adjusted and total returns" compared with market-cap weighted products, according to BlackRock’s website. The high-yield ETF excludes issuers with relatively high default probabilities and weights the remaining bonds by their default-adjusted spreads on the theory that investors often overprice riskier securities.
"We feel that people are more concerned about avoiding defaults with high yield, so there’s a bigger emphasis on quality there," said Nestor.
The iShares Edge Investment Grade Enhanced Bond ETF, an investment grade fund with the ticker symbol IGEB, applies similar screens to a universe of bonds rated BBB or higher.
The securities in the investment grade fund have an effective duration of around seven years and average yield of around 3.4 percent, while for the high-yield ETF, it’s around four years and an average yield of 5.6 percent, according to the firm’s website.