Credit: Shutterstock photoBy Clayton Fresk , Stadion Money Management Portfolio Manager
There has been a bit of publicity recently surrounding the impressive performance of, and the massive flows into, investment grade corporate bond ETFs.
However, on the flip side of this is concern over some weakening technical and fundamentals of the asset class. Investment grade issuance has been high and the credit quality of the underlying issuers is weakening. For many investors, moving out of the asset class may not be an option. However, given a number of fundamental and issuer weighted ETFs in the market in the Investment Grade Corporate space, some of these concerns could be mitigated via the smart beta offerings.
In the following, I will dig into two different alternatively weighted ETFs that focus on the broad space:
There are other ETFs that focus on investment grades corporates, which include:
- PFIG - PowerShares Fundamental Investment Grade Corporate Bond
- SKOR - FlexShares Credit-Scored US Corporate Bond
However, these ETFs focus on the intermediate part of the IG market (i.e., 10 years and in). While these may prove to be powerful replacements for those looking at replacing intermediate corporate exposure, for this analysis I focus on the broad names only.
Here are some quick stats on the ETFs themselves:
One initial takeaway is that the assets and trading volume in these names are currently dwarfed by their larger traditionally weighted counterparts. However, adoption in the smart beta fixed income has knowingly been slow, but, given some of the aforementioned concerns, use of these names could increase as the smart beta revolution continues.
Starting with the broad names, I will run a comparison against the Barclays US Corporate Bond Index (LUAC) to see how characteristics may differ. Generally, the overall duration and spread exposure do not differ dramatically, with the biggest difference being CBND running about a year shorter in duration at 6.5 years, versus WFIG and the index at about 7.5 years. This difference is housed on the long end of the curve, which is illustrated in the key rate chart below.
Next, I will look at the difference in rating exposure using the Bloomberg Composite rating.
The biggest difference here is the overweight in BBB-rated bonds for both ETFs versus that of the index. This is a function of the issuers (via the index) quantifying stronger issuers (by their metrics) and higher relative value in that rating bucket.
This differential is also evidenced by comparing the underlying industry exposure using the Barclays classification schema.
A couple differences of note:
- CBND has a smaller industry divergence versus the broad index, with one exception being a higher REIT and lower Bank exposure
- WFIG has a bit more divergence, particularly in the overweighting to industrials (i.e., in the Telecom and Non-Cyclicals)
One commonly raised drawback of the traditionally weighted indices/ETFs is that the companies that issue the most debt have the highest weighting. While not always the case, this increased issuance may be of detriment to the issuer quality. These alternatively weighted ETFs have the flexibility to reduce said weighting if deemed necessary by the process. In the example above, CBND has a much lower weighting to banks, which is the largest industry exposure in the index due to common names such as Bank of America and JP Morgan. This also brings about a difference in methodology between the ETFs. While Bank of America is one of CBNDs largest underweights relative to the index, WFIG is actually overweight the issuer by nearly 1.5%.
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The logical next question is if this alternative weighting adds value. To examine the question I looked at the total return and excess returns series for the CBND index (ISCU) compared to that of LUAC, allowing for an apples-to-apples comparison. Since the ISCU inception in March 2008 through the end of August 2016, the ISCU index outperformed LUAC by 3% on a total return basis (71.3% vs 68.3% cumulative). Additionally, ISCU had an additional excess return of about 4% cumulative, meaning the total return differences were not just a function of a different duration profile. Additionally, a majority of the months in which ISCU had a stronger relative excess return came out of the bottom of the 07-09 bear market.
As is common knowledge by now, the smart beta craze has taken over the equity space. While there are names available in the fixed income ETF space, adoption has been slow. It may just be that a catalyst is needed to get investors out of what may be deemed a fixed income complacency and to spark their interest. Hopefully, however, such interests are sparked before the benefits of an alternatively weighted ETF are in the rearview mirror.
Clayton Fresk is a Portfolio Manager at Stadion Money Management , a participant in the ETF Strategist Channel .
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Disclosure Information:
Past performance is no guarantee of future results. Investments are subject to risk and any investment strategy may lose money. The investment strategies presented are not appropriate for every investor and financial advisors should review the terms and conditions and risks involved. Some information contained herein was prepared by or obtained from sources that Stadion believes to be reliable. There is no assurance that any of the target prices or other forward-looking statements mentioned will be attained. Any market prices are only indications of market values and are subject to change. Any references to specific securities or market indexes are for informational purposes only. They are not intended as specificinvestment adviceand should not be relied on for making investment decisions. The Barclays US Corporate Bond Index measures the investment grade, fixed-rate, taxable corporate bond market. It includes US Dollar denominated securities publicly issued by US and non-US industrial, utility, and financial issuers. One cannot invest directly in indexes, which are unmanaged and do not incur fees or charges. The "30d ADV" refers to the average daily trading volume over the previous 30 days for the security listed. Founded in 1993, Stadion Money Management is a privately owned money management firm based near Athens, Georgia. Via its unique approach and suite of nontraditional strategies with a defensive bias, Stadion seeks to help investors-through advisors or retirement plans-protect and grow their "serious money." Contact Stadion at 800-222-7636 or www.stadionmoney.com . SMM-092016-666
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.
This article was provided by our partner Tom Lydon of etftrends.com.
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.
