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Funds Implement Factor Investing for Equity and Fixed Income Differently

This article was originally published on ETFTrends.com.

There’s been a lot of focus lately on bonds, especially with the return of volatility spurring more investors to dive into fixed income options. With the need to get more strategic, factor investing is an option, but a recent study found that the way pension funds implement the strategy in equities and fixed income differ from one another.

In the academic paper, Do Institutional Investors Manage Factor Exposures Strategically?, Dirk Broeders from Maastricht University and Kristy Jansen from Tilburg University looked specifically at how institutional investors use factor investing as part of their core investment strategies.

“Broeders and Jansen find a striking difference between factor investing in equity and fixed income portfolios,” wrote Amanda White in Top 1000 Funds. “Based on two key findings the authors claim that pension funds manage equity factor exposures strategically. First, value, momentum, carry, and low beta factors explain differences in expected equity returns between pension funds to a large extent. Second, the factor exposures for equity portfolios are stable over time.”

From a prima facie standpoint, it appears that using factors to guide investment decisions in equities would help smoothen out any volatility in the stock market. Will this same strategy translate to the bond market?

Not necessarily—as the study found.

“By contrast, support for strategic decision-making in fixed income factor exposures cannot be found,” White wrote. “Differences in expected fixed income portfolio returns across pension funds are mainly driven by market exposures. The impact of long-short factor exposures on return differences is negligible. In addition, over time the fixed income factor exposures vary much more than strategic decision-making would suggest. The average fixed income factor exposures can get as low as -0.6 and as high as 0.8.”

Negligible Effects

Investors who want factor-based, smart beta fixed income options with exchange-traded funds (ETFs) can look at the ProShares S&P 500 Bond ETF (SPXB) . The fund seeks investment results that track the performance of the S&P 500®/MarketAxess Investment Grade Corporate Bond Index, which consists exclusively of investment grade bonds issued by companies in the S&P 500.

Additionally, investors can also get smart beta strategies from funds like the Invesco Multi-Factor Income ETF (CBOE:IMFI) . IMFI follows the Invesco Multi-Factor Income Index. That benchmark “is designed to provide multi-factor exposure to fixed income securities in the following weights: 25% in mortgage-backed securities, 25% higher-quality US investment-grade, 25% high yield, and 25% emerging markets debt,” according to Invesco.

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