Better Research for Fixed Income ETF Investors

by on August 11, 2014 | ETFs Mentioned:

The inevitable interest rate hike has prompted many investors to re-think their equity exposure, and perhaps more importantly, their allocation to bonds in recent weeks. Founded in early 2004, AltaVista Research recently announced the launch of its Fixed Income ETF Coverage via the firm’s ETF Research Center website, which is aimed at helping investors to more favorably position their portfolios as the interest rate environment evolves [see also Bond ETFs for Every Objective].

The firm recently took time to explain the appeal behind its latest research offering focused on bond ETFs.

ETF Database (ETFdb): What prompted AltaVista to launch a fixed-income research report?

AltaVista (AV): Although still dwarfed by assets in equity ETFs, fixed income funds continue to grow in importance with strong inflows, and frankly more and more clients had been asking us to add fixed income funds to our research mix. In particular, not having fixed income funds available within our Portfolio Builder tool, which allows users to build and monitor all-ETF portfolios, was a missing piece of the puzzle. That has now been solved.

Investors Concerned About Inflation May Be Interested In The New Pimco ETFETFdb: What sort of client does your firm target? What is their biggest dilemma when they come to you?

AV: Our primary target market is financial advisors – often independent – as well as sophisticated individual investors. These advisors are already familiar with the many benefits of ETFs, but face a daunting task selecting the best funds for each client. They realize that the biggest and/or cheapest funds in each category aren’t necessarily best suited for each particular client.

Our research helps investors sort through the many competing claims, and goes well beyond examining past performance, which is often a contrary indicator for an ETF! Instead we conduct a fundamental analysis of each underlying security in an ETF, and roll that data up to the fund level so that investors can view and value the ETF in a very disciplined yet familiar way. The primary benefit of this approach is that it is forward-looking [see also 25 Things Every Financial Advisor Should Know About ETFs]. 

ETFdb: What is proprietary about this fixed-income ETF research?

AV: As with equity ETFs, we conduct a fundamental analysis of each fund’s underlying constituents. For fixed income funds, this allows us to estimate, for example, the likely change in a fund’s price in response to changes in interest rates, based on the duration and convexity of each security in the fund. We think this information is quite useful to financial advisors trying to position clients’ portfolios for an eventual increase in interest rates.

Another important proprietary data point is the default-adjusted yield to maturity, which is also embedded in our ALTAR Score™ rating. This helps investors determine whether they are being adequately compensated for higher risks of lower-credit quality issues.

ETFdb: How long have you been covering ETFs for? Do you see this product structure as the preferred means for building diversified, low-cost, long-term portfolios?

AV: We started a decade ago. Back then we had no idea how rapidly the ETF space would grow, but we knew that ETFs were the perfect tool for asset allocation, allowing investors to move in and out of sectors, countries, market cap segments, etc., cleanly and efficiently.

One of the things we learned along the way, however, was that there is nothing sacred about the well-known cap-weighted indices like the S&P500, and that alternative approaches like fundamentally-weighted indices, can be—but aren’t necessarily—better for the client. With the right information, an advisor is able to make an informed judgment. That’s what we aim to provide.

ETFdb: What is your fixed income research showing in the current environment, in terms of where to find good value, and what areas to avoid?

AV: This probably won’t come as a surprise, but funds tracking high-yield or “junk” bonds appear really stretched in terms of valuation. Sure, they offer relatively high current yields in our low-yield world, but according to our default-adjusted yield to maturity measures, which are based on historical default and recovery rates for bonds of similar quality and maturity, those relatively high yields are likely to be eaten by the hit from defaults over time.

Instead, we think that investment grade corporate debt funds such as the iShares iBoxx Investment Grade Corp Bond ETF (LQD) and Vanguard Intermediate Corporate Bond ETF (VCIT) offer better value, with still decent spreads over Treasuries given minimal default risk.

The Bottom Line

Investors looking to diversify their portfolio with bonds ought to take into consideration the inevitable rate hike that is approaching on the home front. Be sure to consider and investigate your bond ETF’s underlying holdings, namely the duration and credit-quality, before pulling the trigger on any one fund in particular.  

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Disclosure: No positions at time of writing.