Fundamental Corporate Bond ETFs and Their Underlying Indexes – WFIG, SFIG, VCSH

As smart-bata strategies are gaining great traction in equity ETF space, this approach is also penetrating into the fixed income verticle. WisdomTree, again, acts as a pioneer in cooking and creating such “smart-bata” bond ETFs. WisdomTree Fundamental U.S. Corporate Bond/WisdomTree Fundamental U.S. Short-Term Corporate Bond, WFIG/SFIG are typical with the former one in a broad, global universe, and the latter on in a short term corporate bond universe. I also listed VCSH, Vanguard Short-Term Corporate Bond ETF, which is a typical bond ETF, serving as a comparison to understand the unique feature of WFIG/SFIG better.

WFIG/SFIG, debuted in April 2016, has since accumulated only$4.99 and $5.0 million assets respectively. The average duration is 6.5 and 2.2 years and there are 64 and 58 holding bonds in each fund.

VCSH, issued by Vanguard in November 2009, holds 2129 securities, with 2.7 years duration on average, it has attracted a colossal $19.12 billion AuM by now. With such hefty asset base, this fund is handy and conducive for investors due to its liquidity measured by average spread: 0.01% and decent expense ratio: 0.07%.

VCSH trails Bloomberg Barclays U.S. 1-5 Year Corporate Bond Index. The methodology is classical and conventional by simply filtering a universe that is composed of “short-term” bonds that mature within the next 1 to 5 years. The top ten holdings are JPMorgan Chase & Co, Goldman Sachs Group, Bank of America Corp, Morgan Stanley, Citigroup Inc. etc, mainly focused in the Industrial and Financial Institutions sectors. Over 70% of its holdings are U.S. domiciled.

WFIG and SFIG, on the other hand, imposed a very different, more complex methodology by adding fundamental factors on selection and weighting. they track the WisdomTree Fundamental U.S. Corporate Bond Index and the WisdomTree Fundamental U.S. Short-Term Corporate Bond Index respectively. In constructing this index, starting from a typical base universe that is composed of U.S. traded, public, liquid corporates, WisdomTree then apply three fundamental factors: Free Cash Flow (FCF) Over Debt Service; Leverage Ratio; and Return on Invested Capital (ROIC) to filter out the bottom 20% group, so the remaining basket of credit is expected to have better absolute returns and exhibit lower volatility. Lastly, recognizing many investors ultimately buy bond strategies for income, an income tilt is added, specifically, an “income score” considering the level of incremental income offered by each bond with respect to multiple risk factors, including the potential for default and interest rate risk is calculated. The income score is compared relative to sector peers and then used to tilt the portfolio weight.

Performance is the most important thing, so let’s dive into historical performance of these three ETFs, in relation to AGG as a benchmark. Unluckily, both WFIG and SFIG underperformed vastly compared to both AGG and VCSH, questioning the validity of “smart beta” approach in the fixed income space?.

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