A:

Smart beta concepts and strategies are being used to create corporate bond funds with alternative rules for construction versus traditional bond indexes. These smart beta concepts seek to create different allocations of fixed-income securities in rules-based passive investment strategies. Although a majority of smart beta ETFs are focused on equities, new smart beta funds are coming to the market as of 2015.

Many traditional corporate bond indexes are weighted based on the amount of outstanding debt of the issuer. The issuers with the highest amount of debt, therefore, receive larger allocations. However, a company with more debt issued is not necessarily a better investment for fixed-income securities. Many fixed-income investors are more risk-averse than those who invest in other asset classes. Ironically, the bond index weighting toward amount of debt issued may actually increase the risk for this type of bond fund.

Smart beta strategies seek to build bond funds based on nontraditional index rules. These bond funds often have elements of passive index investing combined with active investing principles. These strategies seek to create a mix of fixed-income assets that have greater returns with lower volatility.

Equal Allocations for Risk

The two main risks when investing in bonds are credit risk, or the risk of a bond issuer defaulting on its obligations, and interest rate risk, or the risk interest rates move higher. Many traditional bond indexes are heavily weighted toward interest rate risk as opposed to credit risk. Some investors may wish to have a more equal allocation between credit risk and interest rate risk. In 2015, BlackRock launched a balanced-risk bond ETF to provide this type of product. Other smart beta funds have focused on allocation by sector, country of origin or bond duration.

RELATED FAQS
  1. How do I use smart beta funds to create a diversified portfolio?

    Learn how smart beta funds may give greater diversification than passively tracking stock indexes and make active management ... Read Answer >>
  2. What are the risks of investing in a bond?

    Learn more about bond market investment risk, including interest rate risk, reinvestment risk, call risk, default risk and ... Read Answer >>
  3. Which factors most influence fixed income securities?

    Learn about the main factors that impact the price of fixed income securities, and understand the various types of risk associated ... Read Answer >>
Related Articles
  1. Investing

    Rising Rates Can Propel Smart Beta Bond ETFs

    Fixed income is viewed as the next smart beta growth frontier. Rising rates could help.
  2. Investing

    Smart Beta Bond ETFs: A Niche to Watch (BYLD, FIBR)

    While smart beta fixed-income funds represent a fairly small niche, the market for them is likely to increase in the future.
  3. Investing

    Fixed Income: A New Smart Beta Frontier

    Fixed income could be the next engine of smart beta ETF growth.
  4. Financial Advisor

    Smart Beta ETFs: Latest Trends and a Look Ahead

    Smart beta ETFs have soared in popularity. These are the latest trends they are following in an effort to outperform the markets.
  5. Investing

    Advisors Are Increasing Smart Beta Use

    Advisors in major ETF markets are boosting smart beta use, but issues remain.
  6. Investing

    Could Smart Beta ETFs Be a $1 Trillion Market by 2020? (BLK)

    One ETF giant believes the smart beta ETF market will grow at double the pace of the overall ETF market over the next several years.
  7. Investing

    Inside The Exponential Growth of Smart Beta ETFs

    Smart beta ETFs are on a torrid growth pace. Here are some of the drivers of that growth.
  8. Investing

    How Advisors Are Using Smart Beta ETFs

    Advisers and money managers are using smart beta ETFs in a variety of ways, which should foster more growth for these funds.
RELATED TERMS
  1. Smart Beta

    Smart beta investing combines the benefits of passive investing ...
  2. Smart Beta ETF

    Smart Beta ETF is a type of exchange-traded fund that uses alternative ...
  3. Beta

    Beta is a measure of the volatility, or systematic risk, of a ...
  4. Bond Fund

    A bond fund is a fund invested primarily in bonds and other debt ...
  5. Bond Market

    The bond market is the environment in which the issuance and ...
  6. Corporate Bond

    A corporate bond is a debt security issued by a corporation and ...
Hot Definitions
  1. Consumer Price Index - CPI

    A measure that examines the weighted average of prices of a basket of consumer goods and services, such as transportation, ...
  2. Moving Average - MA

    A moving average (MA) is a widely used indicator in technical analysis that helps smooth out price action by filtering out ...
  3. Stop Order

    A stop order is an order to buy or sell a security when its price increases past a particular point in order to limit losses ...
  4. Inflation

    The rate at which the general level of prices for goods and services is rising and, consequently, the purchasing power of ...
  5. Candlestick

    A chart that displays the high, low, opening and closing prices for a security for a single day. The wide part of the candlestick ...
  6. Indicator

    Indicators are statistics used to measure current conditions as well as to forecast financial or economic trends.
Trading Center