BlackRock’s exchange-traded fund arm has outlined some of the practical hurdles the fixed income ETF market faces before smart beta strategies are introduced.
Speaking at a roundtable event, iShares’ European head of fixed income product strategy Brett Pybus said there is a lot of work to be done before bond ETFs with a smart beta underlay are brought to market.
Smart beta strategies aim to add value by selecting, weighting and rebalancing portfolio holdings using certain characteristics to control risks and deliver targeted outcomes.
In terms of what they look like in practice, Mr Pybus said fixed income is a less defined concept when compared to equities.
“One of the things that has been happening in fixed income markets for a long time is customising indices,” he said, adding certain strategies have entered the market which “could be construed” as smart beta, but have not been packaged up and sold that way.
Mr Pybus said there are a number of aspects around fixed income which “raise the bar” for creating products in the same way as equities, including underlying liquidity and transaction costs.
“You can come up with a lot of theoretical ideas which intuitively make a lot of sense, but the practical implications of implementing them mean in essence the market cap-weighted indices actually set the bar pretty high.”
He added there is “a lot of talk” in Europe about smart beta ETFs, but clients have not been clear about how they would put them in portfolios.
Mr Pybus said: “There are a lot of practical hurdles to these products, and I think there is still a lot of work to be done around how it would fit in a portfolio in a packaged ETF format.”
BlackRock has no immediate plans to introduce a smart beta ETF, but Mr Pybus said the firm was currently looking at ways to bring this to the market.
Talking about the use of bond ETFs among advisers, Matt Tucker, head of iShares’ fixed income strategy team, said he would put advisers in three broad categories: passive investors; active investors who want to use ETFs to put on their own positions; and active investors who outsource to an active manager.
“ETFs fit into the range of options an adviser has, and it depends on their sophistication and comfort with managing fixed income markets,” he explained. “The question is, do they want to take that upon themselves or hire an expert?”
Advisers can get one hour’s worth of structured CPD by reading last month’s FTAdviser Guide to Smart Beta.
Marvin Evans, principal of Old Bank Wealth Management, said: “Liquidity and transaction costs seem to be the problem when designing smart beta bond EFTs. If they can bring such vehicles to the market at a competitive cost I am sure they would be supported.
“For the time being IFAs tend to use a variety of strategic, actively managed bond funds depending upon the underlying requirement in the portfolios they run and dependent upon what their clients are trying to achieve.
“Where IFAs outsource to an active manager, it is important to keep ongoing charges down. Combining ETFs with active fund management is an effective way of achieving this.”
katherine.denham@ft.com
