Over the past couple of months, Russ Koesterich has been outlining his outlook for markets and economies in the coming year. In short, he believes the most likely scenario is that the world – in particular the US – will continue to see slow but stable growth in 2013, with developed markets increasingly being influenced by policy decisions.
Turning to bond markets specifically, perhaps the biggest factor shaping 2013 is the ongoing low interest rate environment, which doesn’t look to be changing significantly any time soon. The Fed has made its intentions clear, targeting an unemployment level with a limit on inflation before being willing to raise rates. Meanwhile there continues to be heightened demand for US Treasuries from non-price sensitive central banks and investors seeking perceived “safe haven” investments. Until the Fed acts and Treasury demand wanes, we’re likely to experience depressed rates for the foreseeable future. [Year of the Bond ETF]
So what are the implications for bond investors? Here are a few strategies to consider:
- Focus on municipals and credit. The hunt for yield will continue to be a challenge in 2013, so we’d expect to see a sustained interest in riskier fixed income sectors such as high yield and investment grade credit bonds. Also, municipal bonds remain competitive on a tax-adjusted basis for US investors.
- Look outside the US. Just as equity investors are reassessing home country bias this year, so are bond investors finding more opportunities outside of the US and, in some cases, outside of developed markets. In 2012, demand for emerging market bond exchange traded products (ETPs) doubled to $20bn. As investors continue to diversify their bond holdings and search for yield, we expect this will remain a popular category.
- Rethink the role of Treasuries. While we’re not likely to see significantly higher rates in 2013, even a modest increase in yields would have a significantly negative impact on Treasury prices. But does this mean that investors should avoid them altogether? Not so fast. As bond investors rotate into the sometimes much riskier sectors mentioned above, it’s important to remember that even a small amount of Treasuries can anchor a portfolio’s risk.
No matter what the outlook is, you should always consider what role fixed income is playing in your portfolio when implementing a bond strategy. Is the objective to provide income? Lower overall portfolio risk? Add diversification? The answers to these questions can be the key to selecting the right bond investment for you in 2013 and beyond.
Matt Tucker, CFA, is the iShares Head of Fixed Income Strategy.