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ETF Specialist

6 Questions to Ask Before Buying a Strategic-Beta Bond Fund

Alex Bryan offers a framework for evaluating strategic-beta bond funds.

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Traditional broad, market-cap-weighted bond index funds have a lot going for them. They harness the market’s collective wisdom, charge low fees, tend to have low transaction costs, and don’t face key-person risk. But the idea of assigning larger weightings to larger debtors isn’t intuitively appealing. In some cases, this approach, together with differences in how the opportunity set is defined, has made these bond indexes a low hurdle for active managers. For example, this market-cap weighting gives broad investment-grade bond benchmarks heavy exposure to low-yielding Treasuries and agency debt.

Strategic-beta fixed-income funds are index-based strategies that attempt to combine the best of active and passive. Most of these attempt to deliver better performance than traditional bond indexes in a more cost-efficient, transparent, and systematic manner than actively managed alternatives. But they face some challenges. Limited data availability has led to slower product development and adoption of strategic-beta bond funds than among stock funds. And it isn’t always clear that strategic-beta funds offer differentiated exposure. Credit- and interest-rate risk are the biggest drivers of bond returns, and many of these funds just repackage these risks, which may be available more cheaply through traditional cap-weighted index funds.

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Alex Bryan does not own shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.