PowerShares Bond ETF Switches Index

The PowerShares Fundamental High Yield Corporate Bond Portfolio has shifted to a fundamental index screening strategy.
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NEW YORK (TheStreet) -- PowerShares recently altered the investment strategy of one of its fixed income-focused products. The renamed PowerShares Fundamental High Yield Corporate Bond Portfolio (PHB) - Get Report now has a fundamental focus instead of a market weighted one, a move which may signal the ushering in of a new era for bond market exchange traded funds.

The change made to PHB has been highlighted as a way to protect investors from heavy exposure to companies most at risk of default. However, the transformation also highlights the broader shift providers are making towards "smart" and alternative weighting ETF products.

PowerShares already boasts a collection of equity-based products which utilize quantitative strategies to provide investors with instruments that both track and (ideally) beat their underlying indexes. A number of these funds trade under the "Dynamic" moniker. High yield bond ETFs such as

iShares iBoxx $ High Yield Corporate Bond Fund

(HYG) - Get Report

and

SPDR Barclay's Capital High Yield Bond ETF

(JNK) - Get Report

take on the corporate bond market by utilizing passive indexes. While effective at providing investors exposure to the market as a whole, a glaring problem arises when using this technique. Oftentimes, the indexes underlying funds such as HYG will be heavily exposed to companies which are the biggest debtors and therefore the most likely to default.

In early August, PowerShares announced that it was to going to make a dramatic change to its PowerShares High Yield Corporate Bond Portfolio. This fund, which previously tracked the

Wells Fargo High Yield Bond Index

(WFC) - Get Report

, has accumulated $220 million in assets and currently changes hands on average, over 100 thousand times each day.

Although it has proven popular, the fund has changed focus as of this month, now tracking the RAFI High Yield Bond Index. Unlike its former index which is similar to HYG and JNK that employ a passive investing strategy, this new index uses a fundamental screening strategy to determine where it places its bets. According to its release, this alteration was made in order to avoid an overexposure to indebted companies.

Going forward, exposure to the corporate bond market will be based on four separate factors. Variables considered when constructing the index include current book value, gross sales, gross dividends, and cash flow. The fund will be rebalanced at the end of every month.

In order to reflect this structural change, the fund's name has also been altered. Today investors will find the PowerShares Fundamental High Yield Corporate Bond Portfolio in the space where the PowerShares High Yield Corporate Bond Portfolio previously presided. Despite boasting a new title, the fund continues to trade under the symbol PHB.

By tracking this new index, PowerShares is introducing the very first corporate bond ETF to employ a fundamental indexing strategy.

At the end of June, prior to the switch, the fund's top holdings included debt issued by

Cricket Communications, Peabody Energy

(BTU) - Get Report

,

Chesapeake Energy

(CHK) - Get Report

,

Supervalu

(SVU)

and

Constellation Brands

(STZ) - Get Report

.

Together, these holdings accounted for 10.5% of the fund's index. Under the fund's new index, PHB's top five positions have only shifted slightly, this time including BTU, AES, CHK, STZ and Bausch & Lomb. These positions now account for a slightly larger chunk of the fund's total assets.

-- Written by Don Dion in Williamstown, Mass.

At the time of publication, Dion Money Management was long iShares iBoxx $ High Yield Corporate Bond Fund.

Don Dion is president and founder of

Dion Money Management

, a fee-based investment advisory firm to affluent individuals, families and nonprofit organizations, where he is responsible for setting investment policy, creating custom portfolios and overseeing the performance of client accounts. Founded in 1996 and based in Williamstown, Mass., Dion Money Management manages assets for clients in 49 states and 11 countries. Dion is a licensed attorney in Massachusetts and Maine and has more than 25 years' experience working in the financial markets, having founded and run two publicly traded companies before establishing Dion Money Management.

Dion also is publisher of the Fidelity Independent Adviser family of newsletters, which provides to a broad range of investors his commentary on the financial markets, with a specific emphasis on mutual funds and exchange-traded funds. With more than 100,000 subscribers in the U.S. and 29 other countries, Fidelity Independent Adviser publishes six monthly newsletters and three weekly newsletters. Its flagship publication, Fidelity Independent Adviser, has been published monthly for 11 years and reaches 40,000 subscribers.