Bond fund portfolio manager Dan Fuss thinks that market capitalization-weighted exchange traded funds make sense, but not for fixed-income assets. For the long term, market-cap weighting is logical but not when it comes to which company is issuing the most debt, he said in a recent report.
"In general, with equities, low turnover and low costs lead to better returns over a long time period," Fuss said in an Investment News report.
Long term investing in the S&P 500 makes sense because over time, the index has a bias to companies with higher market caps, said Fuss. When you give market-cap weighting to fixed income, the index is giving the most weight to the company issuing the most debt.
"It's the biggest borrowers I'm supposed to give money too? Who's supposed to go broke here?" he asked.
Fuss manages the $20 billion Loomis Sayles Bond Fund (LSBRX).
The area of most concern? Fixed income in non-liquid markets such as high-yield bonds is an area of caution not because of the product itself, rather, for the way investors are using them, reports Jason Kephart for Investment News. In a high-yield market, returns are driven by investor money coming in or out. If there are large inflows, the fund is doing well.
However, when there are large outflows, the ETF can be forced to sell to meet the redemptions, and fund managers are left trying to sell into an illiquid market. Fuss says that this is what creates price discrepancies and big losses.
In closing, Fuss is not bullish on the fixed-income market, for ETFs and otherwise. Rather, Fuss prefers emerging and developed foreign markets with good interest rates and healthy currencies.
Tisha Guerrero contributed to this article.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.