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Chicago, IL – April 24, 2012 - Stocks and funds in this article include: SPDR Barclays Capital Issuer Scored Corporate Bond ETF (CBND), PowerShares Fundamental Investment Grade Corporate Bond Portfolio (PFIG), PowerShares Fundamental High Yield Corporate Bond Portfolio (PHB). Eric Dutram examines three often overlooked bond ETFs which could be better choices for investors seeking lower risk in the fixed income world.
Are the Fundamental Bond ETFs Better Fixed Income Picks? written by Eric Dutram of Zacks Investment Research:
Bond ETFs have become increasingly popular in recent years as a great way for investors to obtain fixed income exposure. These products allow many to gain access to a wide variety of bonds in a single ticker, allowing investors to better diversify their portfolios into this important asset class.
Yet, while many bond ETFs are widely held and traded, they still have some issues. Many major bond ETFs focus in on debt issuance to determine the size of a bond’s holding in a particular ETF. This promotes the firms with the most amount of debt to the largest holdings, suggesting that those who are more in debt take up the biggest spots, not the most ideal situation for risk adverse investors (read Follow Buffett With These Developed Market Bond ETFs).
Additionally, thanks to the massive size of many major bond indexes, a replication strategy must be used, suggesting that returns may deviate slightly from what investors might be expecting. This trend could be further exacerbated by limits on size and liquidity which tend to be more of an issue with multi-billion dollar bond funds than smaller products in the equity space.
In order to avoid this, many investors have looked to actively managed bond ETFs in order to escape the issues. Unfortunately, some of these products have failed to live up to expectations and have weak trading volumes. Lastly, all products in the active bond ETF space have fees that are well above their passive index tracking counterparts, sometimes as much as a full 100 basis points higher.
However, some might not be aware of a ‘third way’ a kind of middle ground between passive and active management in the bond ETF world. Funds that subscribe to this methodology use a fundamental index which looks to strip out some of the notes that are perceived to be of the lowest quality or have minimal potential for capital appreciation going forward (see Go Local With Emerging Market Bond ETFs).
This can help these funds to outperform some of their extremely passive index based counterparts while at the same time, keeping fees much lower in these products than what investors find in the active space. As a result, they could be the best choice for investors concerned about the fixed income world but are still looking to maintain some level of exposure to the bond ETF world.
Below, we profile the three bond ETFs that use this methodology. All three use various fundamental factors in order to assign weights or determine bond holdings. With this approach, there is hope that investors can obtain a better bond ETF investing experience while still keeping fees at a minimal level:
SPDR Barclays Capital Issuer Scored Corporate Bond ETF (CBND)
This fundamentally-weighted bond ETF takes a different approach to investing than what many are used to. Instead of weights by total debt outstanding, the fund tracks the BarCap Issuer Scored Corporate Index which looks to measure firms on a number of financial ratios in order to determine weights.
These ratios include; return on assets, interest coverage ratio, as well as the current ratio. Individual security weights are then calculated by the relative market value of each eligible security, so long as the issues have at least $250 million in bonds outstanding and are U.S. dollar denominated and investment grade (read Is The Bear Market For Bond ETFs Finally Here?).
In total, the ETF holds just over 490 securities in its basket putting a heavy focus on intermediate term bonds. Thanks to this, the ETF has a modified adjusted duration of just 6.1 years, suggesting somewhat low interest rate risk…
For the rest of this ETF article, please visit Zacks.com at: http://www.zacks.com/stock/news/73531/are-the-fundamental-bond-etfs-better-fixed-income-picks
Disclosure: Officers, directors and/or employees of Zacks Investment Research may own or have sold short securities and/or hold long and/or short positions in options that are mentioned in this material. An affiliated investment advisory firm may own or have sold short securities and/or hold long and/or short positions in options that are mentioned in this material. In particular, Eric has a position in PHB, a security mentioned in this article.
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Contact: Eric Dutram