GSAM, BlackRock, JPM Crowd into Smart Beta Bond ETFs
A flurry of factor-based fixed income funds is coming as asset managers see untapped market.
There are few factor-based fixed income funds on offer, but asset managers including Goldman Sachs Asset Management, BlackRock, and J.P. Morgan Asset Management are racing to change that. Factor-based funds, often called smart beta, invest via rules built into an algorithm that doesn’t require humans to intervene once it is set in motion. Smart beta equity funds, which provide exposure to investing styles such as value or low volatility, are one of the fastest growing asset management categories. Institutional and retail investors are flocking to smart beta in the equity world as an alternative to passive products that simply track market capitalization-weighted indexes such as the Standard & Poor’s 500.
Passive fixed income is now dominated by funds that track these type of standard benchmarks, including BlackRock’s LQD, an investment grade corporate bond ETF, and State Street Global Advisors’ JNK, a high-yield fund.
Goldman Sachs Asset Management, which recently launched a smart beta investment grade corporate bond ETF, will soon roll out a high-yield product and an emerging markets sovereign debt ETF denominated in local currency.
Steve Sachs, GSAM’s head of capital markets, notes that popular indexes for passive fixed-income investing — the Bloomberg Barclays U.S. Aggregate, for example — weren’t constructed for investment purposes. In these market cap-weighted indexes, the more debt a company issues, the higher its representation in the benchmark. “That’s not necessarily the best measure of what is a better bond,” Sachs says. For its new corporate bond ETF, GSAM is tracking an index it developed with Citigroup.
GSAM uses the bank’s proprietary equity research to take a fundamental view on the health of companies that will ultimately make up the Citi Goldman Sachs Investment Grade Corporate bond index. Once it has screened companies based on a number of characteristics, it excludes the bottom 10 percent. “That’s economically intuitive,” Sachs says. In fixed income — as opposed to equities with unlimited upside — he points out that investment success is often determined by what is not in the portfolio. Typically, investors simply collect interest on a bond and then receive the principal back when it matures. Avoiding the worst companies reduces the risk of an investor holding a worthless bond.
“Is there a better way to index? We think there is,” Sachs says.
J.P. Morgan Asset Management and BlackRock have also made smart beta bets in fixed income. This week BlackRock launched the iShares Edge Investment Grade Enhanced Bond ETF and the iShares Edge High Yield Defensive Bond ETF. The move gives it a total of four smart beta bond funds. The new high-yield product aims to be more defensive than the broader market and whereas the investment-grade fund’s aims to offer potential for higher yield. The funds are the first to use indexes built with BlackRock’s own intellectual property, analytics, and modeling, the company said.
Andrew Ang, BlackRock’s head of factor investing strategies and a prominent factor researcher, says the firm will continue to study smart beta in fixed income and potentially create additional products. “All of the same factors that are present in equites are also present in fixed income. But the most important effects or factors are rates and credit, so it’s a challenge to tease out other factors such as value or momentum. But it’s clearly possible,” Ang says.
