How do advisors evaluate whether an actively managed bond exchange-traded fund will effectively diversify clients’ portfolios?

Such ETFs have the potential to help achieve diversification goals, but choosing the right fund requires knowing the managers’ history and more specifics about what assets the fund holds.

“You have to ask, ‘What am I actually getting in this package?’” rather than just looking at bond correlations with a client’s existing equity investments, Rob Brown, chief investment officer and chairman of the investment committee for United Capital Financial Life Management in Newport Beach, Calif., said about embarking on such a strategy.

Overall, there are sharp distinctions between actively managed bond ETFs and traditional bonds that investors must recognize.

Investors buying individual bonds will see their interest rate risk fall over time and expect principal repayment at maturity. By contrast, bond ETFs persist indefinitely.

Chief among the appeals of actively managed bond ETFs are their low prices.

“It’s a good way to get fixed income cheap. They are one tool that you can use to reduce volatility,” said Nicholas Reisenbichler, product manager of mutual funds and alternative investments at Louisville, Ky.-based Hilliard Lyons.

Because of the nuances and interest rate sensitivity depending on the exposure that bond funds in general have to government debt, he prefers actively managed bond ETFs, despite the typical increase in expense ratios tied to them.

Reisenbichler chooses among those actively managed ETF bond funds based in part on the managers’ past performance with mutual funds, since that history is longer.

Philip S. Blancato, chief executive and president of New York-based Ladenburg Thalmann Asset Management, views certain years’ track records as the best ways to highlight an actively managed ETFs managers’ skillset, specifically for diversifying a client’s portfolio with equity.

He looks at their performance during years when stress entered the market.

“2008 is a great example of when the S&P 500 was down 37 %, but the iShares Barclays 7-10 Year Treasury Bond ETF (IEF) was up 18% and the iShares iBoxx $ High Yield Corporate Bond ETF (HYG) was down 18 %. This is a great proxy to see how a strategy was positioned and managed during a time of significant volatility,” Blancato said.

Miriam Rozen writes about the financial advisory industry and is a staff reporter for Texas Lawyer.

This story is part of a 30-30 series on smart ETF strategies.

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Miriam Rozen

Miriam Rozen, a Financial Planning contributing writer, is a staff reporter at Texas Lawyer in Dallas.