Eugene Fama and Kenneth French’s landmark research on the influence of various factors on portfolio returns helped spur the massive growth in the smart beta funds category. Morningstar says roughly $800 billion is now invested worldwide across 1,500 factor-based exchange-traded products, up from around $600 billion two years ago. (Factor investing and smart beta are mostly interchangeable terms.)

Typically, the factor story has been about equities. But now bonds are likely to get their turn in the factor spotlight.

Exchange-traded fund sponsors have been rolling out fixed-income ETFs pegged to the same factors they have been using to evaluate stocks—by their value, quality and momentum. This relatively new genre of funds straddles the line between low-cost passive ETFs and higher-cost actively managed funds. And there is a growing body of empirical evidence suggesting that factors can aid credit investing in a robust fashion. Strategists at Invesco have analyzed fixed-income markets over the past decade and found that factors may have played a role in the typical fixed-income manager’s outperformance.

The cost of actively managed bond ETFs can be surprisingly high. Bond giant PIMCO, for example, charges a 1.09% expense ratio for its PIMCO Enhanced Low Duration Active ETF (LDUR) and 0.76% for the PIMCO Active Bond ETF (BOND).

Todd Rosenbluth, director of ETF and mutual fund research at CFRA Research, says factor-based bond ETFs deploy “tools being used by actively managed bond funds, but at much lower cost.”

And given the current low-yield environment for most bonds, every penny matters. “Even if you can save 25 basis points in fees per year, that can really add up,” says Karen Schenone, fixed-income product strategist at iShares. There are five iShares bond factor funds with an average expense ratio of 0.28%.

There’s one small challenge in the bond factor approach. As Greg Friedman, Fidelity’s head of ETF strategy and planning notes, “Fama and French built their research on equities.” Still, his firm and others have back-tested fixed-income returns using factors and found that they have delivered alpha over time.

The short track record for these funds creates another conundrum. Schenone says that “the understanding and knowledge of these funds are still low,” adding that many investors want to see three-year or even five-year track records before buying in. “Anyone launching bond factor funds needs to be in it for the long haul,” she adds. “It will take time to demonstrate that performance.”

Most of the factor-based funds have yet to amass a sizable asset base. “The strategies sound appropriate, but investors have been slow to adopt them,” says Rosenbluth. “There’s an education challenge here. It’s not the simplest approach to explain.”

First « 1 2 3 » Next