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The Next Frontier in Smart Beta: Fixed Income

Fixed income is one of the untapped corners of the smart beta market, and we should expect to see more fixed income strategies launched in the space, according to a panel at TD Ameritrade Institutional’s National LINC conference on Thursday.

Of the $2 trillion in total ETF assets, one-fifth are in smart beta, or strategic beta, strategies, said Ben Johnson, director at Morningstar. In 2015, there were $69 billion in net new flows into these strategies.

Most of those flows were into equity strategies, said Kieran Kirwan, director of investment strategy at ProShares. He expects smart beta to follow the course of the general ETF market, where early adoption of equity funds was followed by a spate of fixed income funds.

“Fixed income is the next frontier for smart beta,” Kirwan said.

Kirwan expects we’ll see fixed income strategies pop up that isolate certain risk factors, such as credit risk or interest rate risk.

There’s been a proliferation of smart beta ETFs, the panel said, which currently represent the majority of new ETF launches. There are now 450 of these ETFs, but there only about a handful of risk factors that have stood the test of time, said Michael Arone, chief investment strategist at State Street Global Advisors. Those include low volatility, momentum, value, size, yield and quality.

Advisors need to approach these strategies cautiously and with a certain level of skepticism, Arone said.

Fees, however, are coming down in these strategies. Last year, Goldman Sachs launched its ActiveBeta U.S. Large Cap Equity ETF at 9 basis points, whereas competitors charge 30 to 40 basis points.

“Where’s there’s growth, where’s there are low barriers to entry, you get competition,” Arone said.

Kirwan believes Goldman is an outlier and that 20 to 40 basis points feels about right for one of these strategies. There is a value in outperformance, he said.

“You want to pay for a quality toothbrush that won’t break.”

TAGS: Fixed Income
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