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Possible Rate Cuts Mean Fixed Income Investors Must Get More Strategic

This article was originally published on ETFTrends.com.

The Federal Reserve has been putting its more dovish side on display, which pivots from 2018’s rate-hiking bonanza with possible rate cuts to come in 2019. Additionally, fixed income investors are facing other challenges like inverted yield curves and signs of slowing global growth, which means that getting strategic is a must in the bond market.

One strategy is to mimic the way funds approach equities, which is via factor investing.

“They want their fixed-income investments done in the same way,” Ian Lumb, head of risk solutions at Axioma, told Markets Media. “That demand-lead change is forcing a pace. I believe in 12 months it is going to be a very different place than where we were 12 months ago. The level of interest in fixed income factor investment and what it takes to get there is not just theoretical: We already see it at conferences and our own events.”

When it specifically comes to single-factor investing, it's important for investors to utilize a strategy that will optimize the decision-making process.

“When looking at a long-only investment benchmark to isolate single specific factors,” said Lumb.” You can only do that through smart portfolio construction with a risk model that understands factor loading and helps isolate the factors that you want to be exposed to and minimize the exposure to the factors to which you do not want to be exposed.”

Getting Active in Fixed Income

Given these challenges, how do investors approach the bond markets? One of the ways is via actively-managed bond exchange-traded funds (ETFs), and on Thursday, two made their respective debuts--the Virtus Seix Senior Loan ETF (SEIX) and Principal Ultra-Short Active Income ETF (USI) .

SEIX seeks to provide investors with a high level of current income via first- and second-lien senior floating rate loans. Senior loans are typically used for business recapitalizations, acquisitions, leveraged buyouts, and re-financings.

The inherent risks associated with senior loans are similar to the risks of junk bonds, but have seniority in the event of borrower default so if the business is forced to sell its assets in a liquidation scenario, the senior loan will be paid first. In addition, senior loans are secured by assets whereas junk bonds are not, making them a more attractive investment option when constructing a loan portfolio.

SEIX will invest in loans that contain floating coupon rates tied to a benchmark lending rate, and are below investment grade or unrated. The floating rate allows investors to capitalize on any short-term interest rate adjustments.

SEIX will be subadvised by Seix Investment Advisors LLC, which will manage investments for the portfolio with a management fee of 0.57%.

With 2018’s year-end sell-offs in U.S. equities, investors are giving value investing a closer look in 2019. A byproduct of a shift to value is a focus on the quality of investments—being selective and using due diligence as screeners to find the best-performing investments.

One corner of the bond market that especially saw an influx of capital was short duration bonds. USI provides this benefit while at the same time, has the active management component. USI will invest in debt issues that seek to maintain both an average effective maturity of three years or less, and an average portfolio duration of one year or less.

USI may hold a mix of fixed and floating rate securities in U.S. and foreign debt from the financial services sector, such as banking, insurance and commercial finance. USI will be managed by Principal Global Advisors—an indirect subsidiary of Principal Financial Group with a cost-effective fee of 0.18%.

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