Weighing Fundamentals

Are traditional bond index funds flawed?

A new bond ETF from Invesco PowerShares Capital Management will completely bypass conventional bond index strategies with a fundamental approach. The newly launched PowerShares Fundamental Emerging Markets Local Debt Portfolio (PFEM) is designed to provide investors a fundamentals-weighted exposure to emerging market sovereign debt denominated in local currencies.

Traditional bond indexes generally use some form of market-cap weighting where constituent weights are a function of both the amount of debt issued and the debt’s current price. This approach can result in greater weights being assigned to issuers that have issued more debt. In contrast, the fundamental index approach developed by Research Affiliates weights bonds based on each country’s economic footprint, resulting in a portfolio that is correlated to a country’s debt service capacity.