BlackRock (BLK), the world’s largest asset manager, and S&P Dow Jones Indices, the largest index provider, are considering extending the concept of enhanced or intelligent indexing, also known as smart beta, to bond indices and funds.
“Bond funds are the next frontier for index designers who use this ‘smart beta’ approach to boost returns by taking advantage of market inefficiencies,” reports Ashley Lau for Reuters. S&P Dow Jones Indices could roll out smart beta bond indices in the fourth quarter, Reuters reported.
Data confirm the rising popularity of smart beta or intelligent index ETFs. There were 335 such ETFs with nearly $300 billion in combined assets under management at the end of 2013. Smart beta ETFs “contributed a record $65.1bn of inflows in 2013 led by dividend-weighted funds, and nearly doubled the $34.2bn from last year,” said BlackRock. [Inflows to Smart Beta ETFs Continue]
As traditional equity-based ETFs that weigh components by market value are dominated by the largest companies, most passive bond indices feature heavy allocations to issuers with the most debt outstanding. Enhanced indexing could shift the focus to issuers’ ability to generate cash or GDP growth for global bond funds, according to Reuters.
Currently, there are a few smart beta bond ETFs on the market. As Reuters notes, one of the more recognizable names in that group is the $2 billion PowerShares Emerging Markets Sovereign Debt Portfolio (PCY) .
PCY, which is almost seven years old, tracks the DB Emerging Market USD Liquid Balanced Index. Constituent countries “are selected annually pursuant to a proprietary index methodology,” according to PowerShares.
That approach gives PCY a lineup that, at the country, is noticeably different from rival funds. No country accounts for more than 4.6% of PCY’s weight and the ETF allocates a combined 18% of its weight to El Salvador, Venezuela, Panama and Colombia.
PCY’s main competitor, the iShares J.P. Morgan USD Emerging Markets Bond ETF (EMB) , uses a more traditional weighting methodology. EMB features no exposure to El Salvador and scant exposure to Panama.
The DB Emerging Market USD Liquid Balanced Index has outperformed the J.P. Morgan EMBI Global Index over the past three years and five years, according to PowerShares data. Year-to-date, PCY has easily outpaced EMB and the Vanguard Emerging Markets Government Bond ETF (VWOB) .
Last month, Russell Investments published a survey showing institutional investors plan to ratchet up use of smart beta ETFs.
Of institutional investors surveyed by Russell with more than $100 billion in assets, 88% “have evaluated smart beta or plan to do so in the next 18 months; 77% of respondents with assets between $1 billion and $10 billion, and 50% of those with assets under $1 billion responded similarly,” said Russell. [Smart Beta Usage on the Rise]
PowerShares Emerging Markets Sovereign Debt Portfolio
ETF Trends editorial team contributed to this post. Tom Lydon’s clients own shares of EMB.
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