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The vast bond-buying programmes introduced by central banks in response to the global financial crisis took fixed income markets into uncharted territory.

Today’s fixed income investors face losses as central banks withdraw quantitative easing and increase interest rates. This is fuelling demand for strategies that offer a more favourable risk and reward.

“Investors know that interest rates have to rise from here and there is a real appetite among clients to find more intelligent ways of managing the risks facing their fixed income portfolios,” says Nizam Hamid, head of exchange traded fund (ETF) strategy for the European arm of provider WisdomTree.

Interest is growing in smart beta as an alternative to traditional bond indices, which end up allocating larger weights to more indebted government or corporate issuers.

Traditional market capitalisation-weighted bond indices “reward the profligate”, explains Yazann Romahi, chief investment officer for quantitative beta strategies at JPMorgan Asset Management.

“There is demand from investors for better diversified fixed income indices, but the challenges in building smart beta strategies for bonds are much more nuanced than in equity markets,” he says.

Smart beta factors such as value, growth and momentum do not easily transfer from equities to fixed income.

Matthieu Guignard, global head of product development and capital markets at Amundi, the French asset manager, says typical equity factors “cannot be applied in fixed income” because sensitivity to changes in interest rates and credit risks are key drivers of bond returns.

Data issues have also inhibited the development of smart beta strategies for bonds. The 10 largest listed US companies have an outstanding combined total of 280 bonds, according to Deutsche Bank, but obtaining accurate data on these instruments can be problematic because many transactions are private over-the-counter deals, unlike trades on a regulated exchange.

Asset manager Invesco is one of the largest providers of smart beta ETFs. It offers US corporate bond ETFs that are weighted by the issuer’s cash flow, sales, book value and dividends. It also sells a gross domestic product-weighted emerging markets bond ETF, where the size of a country’s economy is used to judge its ability to repay its debts.

Paul Syms, head of fixed income product management, Emea, at Invesco PowerShares, reports “a real thirst” among investors to understand such strategies. According to Invesco research, more than half of investors who do not currently use smart beta would consider applying its techniques to equity investment. But their interest in applying smart beta to fixed income ranges from 24 per cent for sovereign bonds to 45 per cent for corporate bonds.

Simon Klein, head of passive investment sales in Europe at Deutsche Asset Management, says demand for smart beta fixed income funds is underestimated, as a large share of the assets are run in undisclosed mandates for institutional investors, rather than in ETFs.

But other managers are sceptical. “Smart beta indexing is a false narrative. I’m not a fan,” says Greg Davis, chief investment officer at Vanguard, the passive investment group. “Investors should be aware that many new products based on back-tested data have produced very different results once they have gone live.”

Rising US interest rates and the end of the bull run for bond markets are forcing investors to rethink their approach.

“Fixed income smart beta is the investment frontier that matters most to clients and we are seeing more strategies under construction. Clients are even willing to trade yield [and accept lower levels of income] if these strategies can help them to control risks in a rising rate environment,” says Mr Hamid.

Copyright The Financial Times Limited 2017. All rights reserved.