Fidelity Opens Fixed-Income Factor ETFs & Lessons from Vanguard’s 401(k) Shakeup

Low Duration BondA financial instrument representing an IOU from the borrower to the lender. Bond issuers promise to pay bond holders a given amount of interest for a pre-determined amount of time until the loan is repaid in full (otherwise known as the maturity date). Bonds can have a fixed or floating interest rate. Fixed-rate bonds pay out a pre-determined amount of interest each year, while floating-rate bonds can pay higher or lower interest each year depending on prevailing market interest rates. & High YieldYield is a measure of the income on an investment in relation to the price. There are several ways to measure yield. The current yield of a security is the income over the past year (either dividends or coupon payments) divided by the current price. ETFsA type of security which allows investors to indirectly invest in an underlying basket of financial instruments (these may include stocks, bonds, commodities or other types of instruments). Shares in an ETF are publicly traded on an exchange, and the price of an ETF’s shares will fluctuate throughout the trading day (traditional mutual funds trade only once a day). For example, one popular ETF tracks the companies in the S&P 500, so buying a share of the ETF gets an investor exposure to all 500 companies in the index. Flesh Out ‘Smart Beta’ Offerings

Call them “smart beta” or “factor,” but whatever the name, Fidelity’s got two more of them for investors—this time in the fixed-income space.

The new exchange-traded fundsA type of security which allows investors to indirectly invest in an underlying basket of financial instruments (these may include stocks, bonds, commodities or other types of instruments). Shares in an ETF are publicly traded on an exchange, and the price of an ETF’s shares will fluctuate throughout the trading day (traditional mutual funds trade only once a day). For example, one popular ETF tracks the companies in the S&P 500, so buying a share of the ETF gets an investor exposure to all 500 companies in the index. (ETFs)A type of security which allows investors to indirectly invest in an underlying basket of financial instruments (these may include stocks, bonds, commodities or other types of instruments). Shares in an ETF are publicly traded on an exchange, and the price of an ETF’s shares will fluctuate throughout the trading day (traditional mutual funds trade only once a day). For example, one popular ETF tracks the companies in the S&P 500, so buying a share of the ETF gets an investor exposure to all 500 companies in the index. both focus on niche areas of the bond market.

The Low Duration Factor
Fidelity Low Duration Bond Factor ETFA type of security which allows investors to indirectly invest in an underlying basket of financial instruments (these may include stocks, bonds, commodities or other types of instruments). Shares in an ETF are publicly traded on an exchange, and the price of an ETF’s shares will fluctuate throughout the trading day (traditional mutual funds trade only once a day). For example, one popular ETF tracks the companies in the S&P 500, so buying a share of the ETF gets an investor exposure to all 500 companies in the index. (ticker: FLDR) tracks an in-house, actively managed index, which in turn comprises investment-grade (i.e., high-quality) floating-rate notes with maturities under five years and Treasury bondsA financial instrument representing an IOU from the borrower to the lender. Bond issuers promise to pay bond holders a given amount of interest for a pre-determined amount of time until the loan is repaid in full (otherwise known as the maturity date). Bonds can have a fixed or floating interest rate. Fixed-rate bonds pay out a pre-determined amount of interest each year, while floating-rate bonds can pay higher or lower interest each year depending on prevailing market interest rates. with maturities in the seven- to 10-year range. The fund charges 0.15% a year in expenses and investors on Fidelity’s platform can trade them commission-free.

Fidelity states the goal of the portfolio is to balance interest-rate and credit riskThe probability that an investment will decline in value in the short term, along with the magnitude of that decline. Stocks are often considered riskier than bonds because they have a higher probability of losing money, and they tend to lose more than bonds when they do decline. to provide a better risk-reward profile than a “traditional” floating-rate-note index or fund. The idea is that the high credit-quality bonds it selects will take care of the credit piece, while the floating-rate-note component will help Fidelity manage interest-rate risk and provide the “low duration” factor in the fund’s name. Here’s how.

Floating-rate notes’ income payouts are not fixed like a traditional bond’s, but instead go up or down based on a benchmark like the prime rate or a Treasury bill’s yield—for this reason, they are less sensitive to changes in interest rates.

Why? Because of the inverse relationship between a bond’s price and yieldYield is a measure of the income on an investment in relation to the price. There are several ways to measure yield. The current yield of a security is the income over the past year (either dividends or coupon payments) divided by the current price.. When yieldsYield is a measure of the income on an investment in relation to the price. There are several ways to measure yield. The current yield of a security is the income over the past year (either dividends or coupon payments) divided by the current price. go up, prices go down and vice versa. Since floating-rate notes’ yields adjust to changes in interest rates, their price doesn’t take the same hit in response to interest-rate moves. As a result, floating-rate notes typically have lower durations than traditional bonds with similar maturities, as the size of their income payouts resets based on interest rates on a regular basis.

Duration is a measure of a bondA financial instrument representing an IOU from the borrower to the lender. Bond issuers promise to pay bond holders a given amount of interest for a pre-determined amount of time until the loan is repaid in full (otherwise known as the maturity date). Bonds can have a fixed or floating interest rate. Fixed-rate bonds pay out a pre-determined amount of interest each year, while floating-rate bonds can pay higher or lower interest each year depending on prevailing market interest rates. fund or ETF’s risk from rising interest rates, measured in years. The higher the duration, the greater the risk if interest rates rise. When it comes to measuring duration risk, the rule of thumb is that for every 1% increase or decrease in interest rates, a fund will see its value rise or fall by 1% for every year of duration. So, for example, a fund with a duration of 5 years would suffer a price decline of 5% if interest rates rose 1%. As discussed, Fidelity’s new ETF seeks to temper that risk for investors.

Seeking High Income
Fidelity High Yield Factor ETF (FDHY) has the goal of providing a high level of income and some potential for growth. Eighty percent of the portfolio will typically be invested in below-investment-grade bonds (also known as “junk” bonds). Fidelity is using a computer-based model to screen bonds to buy, focusing on those with the best return potential and the lowest probability of default. The people behind the machines will then actively select among the pool of approved bonds to reduce trading costs.

Like the Low Duration Factor ETF, High Yield Factor ETF can be traded commission-free for investors on Fidelity’s brokerage platform. The ETF charges 0.45% a year in fees.

Fidelity’s Factor Lineup
The new funds flesh out Fidelity’s factor ETF lineup, which includes eight U.S.-focused portfolios and two foreign ETF offerings.

We remain a bit skeptical of the entire “smart beta” or “factor” movement—in some cases, fund providers’ motivation seems to be more about marketing than creating high-quality investment products. Time will tell how successfully Fidelity and other fund companies’ offerings deliver for investors.

Vanguard Eliminates Employee Access to 12 Funds

Unless you work for Vanguard, this story might not seem relevant to you. But bear with us.

Last week, we learned that Vanguard is changing the funds lineup in its internal 401(k) planA 401(k) plan is a retirement account that a company sets up on behalf of its employees. Both the participant and the employer can contribute to the account. There are two types of 401(k)s, traditional and Roth. Income invested in traditional 401(k)s isn’t taxed while it’s invested, but is taxed when it’s withdrawn. Income invested in a Roth 401(k) is taxed before it’s invested, but no tax is paid when it is withdrawn.. The headlines noted that the Malvern, PA fund behemoth eliminated employee access to its iconic 500 Index fund (along with 11 other funds).

The move is intended to shift money in the funds being dropped into the firm’s Target Retirement funds, a lowest-common-denominator approach to saving for retirement that uses a single metric, year of planned retirement, to dictate portfolio allocation.

Not So Select Anymore
Of the dozen funds excised from the 401(k) plan, eight are what Vanguard calls “Select” funds. These are funds that Vanguard says have a combination of low costs, diversificationA strategy for managing investment risk by investing in a mixture of different investments. Since different asset classes face different risks, even if one type of asset declines in value, others may not., size and longevity that will accrue to investors’ benefit in a portfolio.

There are currently 21 funds on Vanguard’s Select list, which includes four broad-market stockA financial instrument giving the holder a proportion of the ownership and earnings of a company. and bond index funds, two money market funds, four short- and intermediate-term bond funds, two balanced funds, six U.S.-focused stock funds and three international stock funds. The list includes both actively managed and index funds, and they are denoted by special “S” symbols on Vanguard’s website. Opinions vary on whether all of the funds included are truly the best Vanguard has to offer. We feel the list is hit or miss, and some of the misses are big ones.

Keep Your Retirement Savings Strategy on Track
Why should the funds available to Vanguard employees in their plan matter to you? Aside from wondering why some funds are promoted as “Select” enough for retail investors but not worth offering to its own employees in the 401(k) plan—you’d have to ask Vanguard that—it’s a good reminder to all retirement-plan investors of how important it is to regularly review the options in your own plan and stay on top of your personal investment allocation.

It is not uncommon for companies to make adjustments to their retirement plans every so often, which can include the lineup of funds offered, the fees charged or even a wholesale change to another provider with all new rules and options to consider and react to (also something to consider when you change jobs).

This is why we recommend reviewing your 401(k) plan options and personal allocation carefully and regularly. It’s worth your while to make sure that you’re investing in a portfolio that will help you reach your goals and is in line with your risk comfort level. You should also pay attention to the fees in your plan—there has been a trend in recent years for larger companies to lower the costs of their plans and provide decent low-cost funds to their participants, but there are still some companies that need to catch up. It’s still not uncommon for plans to have high, uncompetitive fees or lackluster investment choices.

The Adviser Investments Advantage
If you feel like your company’s 401(k), 403(b) or other retirement plan options are not up to par and would like some advice, we’re here to help. We’ve advised many clients on how best to allocate their retirement plan portfolios and we also provide comprehensive advisory services to companies looking to improve their plans.

Whether you’re an individual investor or a business owner or board member, we’d be happy to review your retirement plan. Please contact us today at info@adviserinvestments.com or call us toll-free at 800.492.6868.

Please note: This update was prepared on Friday, June 15, 2018, prior to the market’s close.

About Adviser Investments

Adviser Investments is a full service wealth management firm, offering investment management, financial and tax planning, managed individual bond portfolios, and 401(k) advisory services. We’ve been helping individuals, trustsA legal document that functions as an instruction manual to how you want your money managed and spent in your later years as well as how your assets should be distributed after your death. Assets placed in a trust are generally safe from creditors and can be sold by the trustee in short order, avoiding the lengthy and costly probate process., institutions and foundations since 1994, and have more than 3,500 clients across the country and over $6 billion in assets under management. Our portfolios encompass actively managed funds, ETFs, socially responsible investments and tactical asset allocation strategies, with particular expertise in Fidelity and Vanguard mutual funds. We take pride in being The Adviser You Can Talk To.

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