Active fixed income ETFs: two ways to strengthen the bond core

Core bond allocations are made to last, often remaining at the heart of portfolios for years. Over that kind of horizon, even incremental improvements in how risk is selected and rewarded can make a meaningful difference.

Yet the opportunities to make those improvements can be easy to overlook.

Our two new SMART Fixed Income ETFs are built to take a deeper view of the bond market, looking beyond headline exposures for opportunities that broad market allocations miss. They bring AllianzGI’s established Advanced Fixed Income expertise into the active ETF format across two complementary parts of the core: euro government bonds and investmentgrade credit. Together, they can offer investors a smarter way to build the bond core for the years ahead.

The SMART EUR Corporate Bond 1-10Y ETF provides a credit core, putting greater emphasis on sectors, spreads, issuer research and individual bond selection.

Both ETFs are designed to preserve the characteristics investors expect from a core allocation while retaining flexibility to look beyond benchmark holdings where our portfolio managers identify more attractive risk-adjusted opportunities.

The 1-10 year range is deliberate, targeting a strategic sweet spot that offers access to attractive yield and liquidity without taking on the much greater interest-rate sensitivity of the very long end of the curve.

The result is precise rather than exotic: recognisably core bond exposures, with more scope to decide which risks are worth taking and where they are best rewarded.

For Maxence Mormède, CIO of Advanced Fixed Income, that means building both ETFs around multiple sources of active return, so that no single rates or credit view is asked to carry the portfolio – while portfolio-manager judgement decides which opportunities deserve the risk budget.

Diversification in fixed income is about more than the number of bonds you hold. A portfolio can contain hundreds of securities and still depend heavily on a small number of macroeconomic factors. Duration and yield-curve positioning in particular can come to dominate active risk.

Our SMART Fixed Income ETFs therefore seek diversification¹ on two levels: across the securities held and across the sources of active return themselves.

In the Government Bond ETF, that means deciding which countries offer the most attractive opportunities, how much interest-rate risk to take, where along the yield curve to take it and which individual bonds best express those views. In the Corporate Bond ETF, the emphasis shifts to selecting sectors and issuers, choosing maturities and identifying individual bonds that offer the best compensation for credit and liquidity risk.

Bringing several complementary decisions together gives the portfolio more than one route to incremental alpha, rather than asking one large rates or credit call to do most of the work.

The ambition is deliberately incremental. Both strategies target 0.30% a year of gross outperformance² within a risk framework of up to 2% tracking error³. The aim is to make each unit of active risk work harder, seeking more return from a defined risk budget rather than simply taking more risk.

Strategy:
AllianzGI SMART EUR Government Bond 1-10Y Strategy

When investing in government bonds, making active risk count starts with understanding where sovereign risk is being rewarded. That requires a view not only on interest rates, but on the underlying strength of individual countries and how that strength is reflected in bond prices.

Our sovereign research looks at debt sustainability alongside growth, inflation and interest-rate dynamics. It also uses multi-layered ratings analysis and our proprietary Sovereign Strength Indicator, which takes account of both fundamental and political risks. That framework currently covers 110 countries, giving our portfolio managers a consistent basis for comparing sovereign risks and opportunities across a wide range of markets.

Portfolio managers can then express their views through country allocation, duration, yield-curve positioning and the choice of individual securities, giving the SMART Government Bond ETF several distinct ways to seek incremental return.

Strategy:
AllianzGI SMART EUR Corporate Bond 1-10Y Strategy

Corporate bonds create a more granular set of choices. It starts with the strength of the issuer, but that is only part of the decision. A single company can have several bonds outstanding, each with different maturities, yields, liquidity characteristics and positions in the capital structure.

Our SMART Corporate Bond ETF therefore combines fundamental credit analysis with relative-value assessment across sectors, issuers and individual securities. The research process considers factors such as financial strength, business model, event risk and country risk, then compares bonds with similar risk characteristics to identify where pricing looks most attractive. The wider corporate research universe spans more than 9,000 issues.

That allows us to answer two key questions: Is this an issuer we want to lend to? And, if so, which of its bonds offers the most attractive compensation for the risks involved? A higher yield is not automatically a better opportunity if it reflects weaker liquidity, greater credit risk or less favourable structural characteristics.

The result is a credit portfolio that seeks to spend its risk budget where investors are being better compensated, rather than simply where yields happen to be highest.

Fixed income markets present a vast opportunity set. Across both strategies, quantitative tools help us scan that breadth to compare securities and monitor changing risks. But markets evolve and old relationships break down, so our portfolio managers combine those signals with fundamental, macroeconomic and market research to make the best possible selections for the portfolio.

Selectivity really counts in fixed income. Bond returns are asymmetric: if an issuer performs as expected, the upside is constrained. If its creditworthiness deteriorates or it defaults, losses can be much higher.

That puts a premium on distinguishing genuinely attractive yield from yield that is simply paying investors to take more risk.

Our emphasis on avoiding poorly rewarded credit risk is supported by the proprietary Advanced Analytics credit assessment framework. Quantitative tools like these help us see more. Investment judgement helps us decide what’s important. In fixed income, knowing what not to own matters just as much as finding what to buy. That discipline is what allows a familiar core allocation to do more.

Making more of the bond core means being more deliberate about the risks taken inside it. Our two SMART Fixed Income ETFs do that differently across government and corporate bonds, but share the same discipline: seek return from multiple active decisions and put research behind every risk taken.

The ETF structure adds transparency, intraday tradability and flexibility. The substance sits inside: our proprietary research, disciplined portfolio construction techniques and human judgement honed over decades.

The ETFs may be new, but the investment approach behind them is not. It draws on fixed income processes successfully applied across AllianzGI mandates since 1999.

That is what we mean by ETFs with substance: a smarter way to build the bond core, combining active investment capability with the flexibility of an ETF.

1) Diversification does not guarantee a profit or protect against losses.
2) Targeted performance does not necessarily predict future returns. No assurance can be given that targeted returns will be met.
3) Please note that it is not a contractual limit and is subject to change without formal notice. There is no guarantee this will be achieved.
4) Targeted performance does not necessarily predict future returns. No assurance can be given that targeted returns will be met.
5) Please note that it is not a contractual limit and is subject to change without formal notice. There is no guarantee this will be achieved.