ETF Expert Corner

Invesco’s Tim Urbanowicz on Factor Bond ETFs, BulletShares

August 28th, 2018 by ETF Store Staff

Tim Urbanowicz, Sr. Fixed Income Product Strategist at Invesco, explains the merits of factor-based bond ETFs and the BulletShares target maturity bond ETFs.



Transcript

You can listen to our interview with Tim Urbanowicz by using the above media player or enjoy a full transcription of the interview below.

Nate Geraci: Jason, briefly here before Tim joins us, I thought it might be good to sort of paint the challenge for bond investors right now. And, look, nothing in investing is ever easy, but I do feel like the bond portion of a portfolio has been especially difficult over the past several years. We've had rates at historically low levels. Those rates have begun to rise - much more on the shorter end of the yield curve - but I think many investors are concerned about rising rates because, of course, just at a basic level as interest rates rise, bond prices fall. So big picture, do you want to park your money in 30-year Treasuries at three percent? Does that seem like a good deal? Would you rather stay on the short end of the curve and hope the economy doesn't backtrack? Do you want to take on credit risk – right - higher yielding bonds? There are a lot of questions here, but I don't think any easy answers.

Jason Lank: There aren't any because most - well, I would say nearly every investor listening - has never been in this spot before. We're coming off generational low interest rates and there are so many challenges obviously from an absolute yield standpoint. You're right. Where do you park your money? I mean the difference between the two year and the ten is just pennies, and so that is such a challenge. Another challenge for many retail investors are the optics of rising rates. You know if you own an individual bond and interest rates go up, you're going to see a paper capital loss, probably until the bond is redeemed unless rates were to back off again. So you're looking at, you know a coupon four times a year for example, but twelve months of the year a paper capital loss until the bond is redeemed. That's tough on the soul in a rising interest rate environment, so you're right. Interest rates, the optics, it's a challenge.

Nate Geraci: Well, let's now bring in Tim Urbanowicz, Senior Fixed Income Product Strategist at Invesco. Invesco is currently the fourth largest ETF provider. They offer nearly 240 ETFs. Those ETFs have close to 200 billion dollars invested in them, and I would say Invesco has really hung their hat on smart beta and factor-based investing, but not just on the equity side. So Invesco actually offers the largest lineup of smart beta bond ETFs, they were really what I would call a pioneer in that space. And then at the end of July, they launched a new suite of factor-based bond ETFs. Also, earlier this year, Invesco completed the acquisition of Guggenheim's ETF business, which included the popular BulletShares defined maturity bond ETFs. So we're going to talk about all of this with Tim here today, who is joining us via phone from Atlanta. Tim, great having you on the program.

Tim Urbanowicz: Great, great to be here Nate.

Nate Geraci: Tim, as I mentioned at the top of the segment, nothing in investing is ever easy, but I do think investors are finding fixed income especially challenging right now. To begin, can you maybe give us your overall view of the current bond market? Do you agree? Is this a more challenging environment than we've seen in a while?

Tim Urbanowicz: No doubt. No doubt this has been and continues to be a very challenging environment for fixed income investors. Just to put this in perspective even further today, if I were to go out there and buy a 10-year U.S. Treasury bond, the yield that I would receive on that bond would be right around 2.87%. That same allocation 10 years ago would have produced a yield right around 4%. 15 years ago it would have produced a yield around 4.5%. And 20 years ago, my yield would have been north of 5%. So, no doubt that is creating some challenges for investors. In recent years, a few different strategies that investors have used to help overcome those challenges - they've done one of two things. They've either added duration risk to their portfolio, meaning that they've gone further out with their investments on the yield curve and thus increased the sensitivity of their portfolios to rising rates. Or B, what they've done is they've added credit risk to their portfolio, meaning that they've dipped down the spectrum and maybe gone from an investment grade portfolio to a high-yield portfolio. While that's worked well in the past, the issue that we see with that going forward is really two-fold. Number one, you've seen this flattening of the yield curve, meaning that the further out you go, the increase in compensation that you're receiving to do that has compressed. On the credit spread side of things, we've also seen a significant compression in credit spreads, or the level of excess compensation that investors receive from dipping down the spectrum on credit quality. Just a couple examples of this, if you look at last August - last August, if I were to go from a two year to a ten year treasury, the boost that I would receive in my yield would be right around 60%. So 60% pickup. Today, that boost, with the flattening of the yield curve that we've seen, that boost would only be about 8%. So that has created a challenge. If we look at credit spreads and the compression that we've seen in credit spreads, last August, if I were to hold an investment-grade portfolio and rotate that to a high-yield portfolio, the pickup that I would get on my yield would be north of 3.3%. Today, that pickup has gone down to right around 2%. So all in all, very challenging environment. To throw a cherry on top of this all is liquidity. The ease of getting into and out of bonds. First of all, it's never been easy to do but if you plop on top of that just all the challenges, post-financial crisis, as dealer inventories, or the amount of bonds that they're holding on their books is dropped, it's become even more difficult and not to mention even more expensive. So all that to say, we completely agree. It's a challenging environment. I think the environment really forces investors to get creative with their fixed income solutions and I think the good news and the good piece about this is that there are solutions, particularly on the ETF side that have been built to help investors navigate the environment.

Nate Geraci: Well, let's talk about some of those solutions. Back in July, Invesco rolled out a new lineup of factor-based bond ETFs. These are 8 ETFs focusing on value, quality, or perhaps a combination of the two. So for example, there's the Invesco Investment Grade Value ETF, ticker IIGV. The Invesco Emerging Markets Debt Value ETF, ticker IEMV. Can you maybe walk us through these ETFs just at a very high level?

Tim Urbanowicz: Sure, absolutely. So just a genesis of those two Nate, you know the legacy PowerShares business, which is now the Invesco ETF business, was really founded on the notion that the ETF represents a very extremely efficient vehicle to deliver an investment strategy in. But looking at what was in the market at that time, the idea was “Okay, can we take that vehicle and put a more investible strategy underneath the hood of that ETF?”. And on the fixed income side, we find this very viable option. You know, if you look at just the way that most debt indices are put together, they're put together based on market value weighting meaning that you are giving a higher weight to an issuer that has more debt outstanding without putting any weight on the fact that, what is their actual ability to service that debt? So, the factor fixed income ETFs - really most of the ETFs that Invesco has - are really built on that premise. The factor ETFs are really an extension of that. So, when you look at factors broadly, factors are nothing more than characteristics or qualities in a security that help explain behavior, say another way that they can really help determine the risk and return characteristics of a given asset class. While these factor fixed income ETFs are new, factor investing in general is really nothing new. In fact, we can trace the origins of factor investing back all the way to the early 1960s. Large institutions have been using factors for decades. What is new, however, is that thanks to the ETF wrapper, you don't have to be a large institution anymore to have access to factor-based strategies. I, as an individual investor, can go out into my brokerage account today when the market is open and get quick, easy access to factor-based strategies now. So nothing new, the only thing that is new is the delivery mechanism in the ETF wrapper. Now the fixed income ETFs, I think are very unique, very interesting. This is very innovative. It's the first that we've seen in the ETF landscape really to give investors access to things like value, to things like quality, or defensive and then combining those in a multi-factor approach, investors now have that access through the fixed income lineup with Invesco.

Nate Geraci: Tim, something that I think is noteworthy about all of these new factor ETFs is that they're all self-indexed, right? They track indexes that Invesco developed in house. What's the benefit of that?

Tim Urbanowicz: The benefit is I think being able to leverage the expertise of a 300 billion dollar fixed income manager in Invesco. You know at Invesco, we have over 226 investment professionals just dedicated to fixed income. With that, you have 73 PMs and traders, over 100 analysts, and really where the expertise is, is in the different strategies. You know the teams that are dedicated to high yield, dedicated to investment grade credit, dedicated to structured securities. So to be able to leverage this long-standing expertise and asset management, and combine that with the ETF platform that has been developed over the last 15 years, it really makes for a unique offering to investors. And one of the big things that our investors like, is it allows us to help keep those cost down by participating in self-indexing. So many benefits, but obviously cost being a big factor in that.

Nate Geraci: Our guest is Tim Urbanowicz, Senior Fixed Income Product Strategist at Invesco. Tim, I also want to talk about the BulletShares lineup. So Invesco acquired this as part of the acquisition of Guggenheim's ETF business earlier in the year. These are target maturity bond ETFs. I always like to say, these combine the best of both worlds. You get the fixed maturity of individual bonds, but you also get the diversification and professional management of bond funds. Why can these be such effective tools, just given the type of environment that we are in right now?

Tim Urbanowicz: Absolutely. Well Nate, I think you hit it right on the head. If you look back to some of the issues that we discussed on the front end - you know interest rates, credit spreads, liquidity - I think the BulletShares were really designed in 2010 at Guggenheim to help address those issues head on. You know, the BulletShares obviously being in an ETF form, offer diversification. You're able to go out there and purchase a single defined maturity ETF in a single ticket. So really, enhancing the ease of purchasing, buying and selling, solving that liquidity issue. But one of the things that the BulletShares address right now, if you look at the rate environment that we're in, they can really help combat the issue of, if we do see rates rise - right? Any ETF or fund out there typically deals with the same issue on the fixed income side. And that is the issue of perpetual duration meaning that as bonds begin to age towards their maturity and age down the yield curve, instead of being held through to their final maturity, like you would an individual bond, those securities are typically sold early and replaced with securities that are further out on the yield curve. Nothing wrong with that, but in and of itself and the environment that we're in, if you do see rates rise, what that potentially introduces is principal risk to the conservative portion of your portfolio. So by holding a BulletShares ETF, the difference is that BulletShares actually take bonds, they hold them through to their final maturity, and the ETF itself actually has a final maturity where net asset value and your final distribution will be placed back into the shareholder account when the ETF itself actually matures and terminates. So, the problems that you're seeing with this low yield environment where it is hard to generate income, you have a hard time going further out in case rates do rise, by being able to piece together maybe a ladder with the BulletShares, very efficiently, maybe buying one, two or three different BulletShares ETFs as those products roll off. Being able to roll those into a newer issue really helps solve that issue. So very special product. I think it's very unique in the fact that they do have a set and defined maturity and really helps with that issue of perpetual duration that you see in most every other fund or ETF out there.

Jason Lank: Tim, this is Jason Lank. Congratulations to you and Invesco on the acquisition. The BulletShares lineup is just fantastic. I can see why you made them a target. But I want to pass along a question to you that I received from a client and that is, beyond the maturity date, let’s say a 2025 corporate, beyond the date the bond matures and that it’s an investment grade corporate, what's the rest of the process for deciding how you fill out the ETF? You can't buy them all. So what's the logic that your managers use?

Tim Urbanowicz: Yep. That's a great question. So the process is very simple. So we have different liquidity screens in place on the front end. We have different size constraints on the front end that give us a universe that we're able to invest in. Once you have that universe, whether it be investment grade where we're just looking at investment grade corporates or high yield where we are just looking at issues that are rated high yield, what we do is we then take that universe and we select and weight the securities based on market value. Now, what I think is different with this in the BulletShares relative to some other strategies, is you're not looking to generate outperformance within the portfolio. You're not going to say one bond is going to outperform the other, so I want to hold this one and not that one. You know the reality of it is, you're holding these bonds through to maturity and if these bonds don't default, they're going to mature at their par value. So that really makes it less important, if you will, to have more of a smart beta tilt in the BulletShares portfolio overall. So at its core, very simple, you have parameters in place. Liquidity screens, size thresholds that are in place to make sure that the index is investible and then we go out there as an ETF provider and sample that particular index.

Nate Geraci: Tim, we only have about two minutes left here. You were mentioning cost earlier when we were talking about the self-indexing. I know when Invesco completed its acquisition of Guggenheim, you actually chopped fees on the corporate bond BulletShares from 24 basis points to 10 basis points, which was a pretty big cut. And then on the factor ETFs we were discussing earlier, fees on those range from, I believe 12 basis points to the most expensive is 29 basis points for the Emerging Markets Debt ETF, very inexpensive. Can you just talk a little bit about the fee positioning here?

Tim Urbanowicz: Sure. Obviously, fee discussion is very important with clients right now. At Invesco, we really try to review all of our products on a regular basis to ensure that our pricing is in line with what clients need and, more specifically, the value that we're delivering to clients in that particular strategy. So for example, with the BulletShares, we had done extensive work really deepening our understanding of what a client needs in that particular strategy and how do we strengthen our pricing process. So that is one of the things that led to that fee cut. You know, the enhanced approached to pricing is really deeply rooted in the understanding of what the client needs and the focus is on delivering against those in a very differentiated way. So we are constantly reviewing and making sure that what we're looking to do is aligned with what our clients are looking to do.

Nate Geraci: Well Tim, we'll have to leave it there. Thank you for joining us. Excellent insight today. I appreciate it.

Tim Urbanowicz: Thank you guys. Have a great day.

Nate Geraci: That was Tim Urbanowicz, Senior Fixed Income Product Strategist at Invesco and if you would like to learn more about their lineup of bond ETFs, you can do so by visiting invesco.com/etfs.