In the week of Mar. 12, the iShares Barclays 20 Year Treasury ETF (Ticker: TLT), which tracks longer-dated paper, fell by 4.1 percent. That's equivalent to a 500-point plus plunge in the Dow, according to Barron's. Our own Stan Luxenberg sent me this note about bond index ETFs: “Rob Arnott says these cap-weighted benchmarks make no sense because they give the heaviest weight to issuers that have the most bonds outstanding.” So does this mean investors are regaining an appetite for risk, selling off Govies for stock funds?
Fundamentally-Weighted Bond Indexes
Equity ETFs that use fundamental weighting developed by Arnott's firm, Research Affiliates, have delivered solid returns. Research Affiliates also creates fundamentally-weighted bond indexes, which could pose a challenge to traditional bond indexes. Funds such as Vanguard Total Bond Market Index track cap-weighted benchmarks, such as the Barclays Capital U.S. Aggregate Bond Index. Because Uncle Sam is the biggest issuer around, the Barclays Aggregate index has much of its assets in government bonds. At a time when the S&P has downgraded U.S. debt, investors may not want to hold a big slug of Treasuries.
The Research Affiliates' high-yield and investment-grade corporate bond indexes have no exposure to Treasuries. And unlike traditional corporate bond indexes, which give the largest weightings to the biggest debtors, Research Affiliates' indexes are constructed using fundamental measures of issuer size rather than market value of debt outstanding.
Arnott has been quite the sensation, even gracing the cover of our magazine as one of our “Ten to Watch” back in 2007. We have written about his case for fundamentally weighted indexes plenty. And one of our bond picks last year — PowerShares Fundamental High Yield Corporate Bond (PHB), based on a Research Affiliates fundamentally weighted high yield bond index — was pretty correct.
Retail investors continue to sell domestic equity funds and buy hybrid funds. Here is what the Investment Company Institute says: “Equity funds had estimated outflows of $126 million for the week (Mar. 12 through Mar. 16), compared to estimated outflows of $2.84 billion in the previous week. Domestic equity funds had estimated outflows of $1.38 billion, while estimated inflows to foreign equity funds were $1.25 billion.”
Ah, the retail investor has once again missed a nice run in stocks, the one that began in October.
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