FA: Do any of the factors researchers have found in equities also apply to fixed income? How should advisors explain factors specific to fixed income, like duration and credit risk, to their clients?
Bartolini: For investors, smart beta approaches in fixed income can be an effective bridge between market-cap weighted index exposures and less transparent, higher cost active management.
Fixed income investors naturally position around duration, credit, term and liquidity in their investments. Couple this with the ability to target different duration and credit profiles, and it becomes clear that fixed income may be a natural place to apply smart beta.
FA: Why has it taken so long to develop the factor-based fixed income index and product space? Factor-based fixed income products, on average, have often underperformed the market-based bond indexes in recent years—do you expect that trend to reverse as more and better smart beta products proliferate?
Bartolini: Smart beta ETFs are still in the early innings, and fixed income smart beta is barely out of the first inning. A lot of hesitation remains for investors gravitating to the space, but that is largely a function of time. As with any strategy built on the promise of potentially improved performance, absolute or risk-adjusted, an adequate surveillance period with a live track record provides some degree of confidence.
Relying on a backtest of how these factors may have performed is a start, but today’s investors require more stringent controls within their due diligence process. The current review process feels similar to active manager due diligence, where consistency of performance over a market cycle such as three or five years is needed for full vetting.
As smart beta due diligence continues to evolve, we will remain at the forefront of providing investors the investment background and perspective they need to analyze, review and implement all types of smart beta strategies.
Financial Advisor magazine: Thanks, Matthew. We look forward to hearing more of your thoughts at the 2nd Annual Smart Beta Strategies Summit October 26th in Boston.
1. Clifford S. Asness, Andrea Frazzini, and Lasse H. Pedersen, 2013 “Quality Minus Junk”
Mark M. Carhat, 1997, “On Persistence in Mutual Fund Performance”
Eugene F. Fama, Kenneth R. French, 1992, “The Cross-Section of Expected Stock Returns
2. SPDR Americas Research as of 08/31/2017
3. Bloomberg Finance L.P. as of 09/14/2017
4. http://www.institutionalinvestor.com/Article/3670089/asset-management-macro/cliff-asness-blasts-rob-arnott-on-factor-timing.html
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