U.S. Treasury debt was something of a surprise performance winner in the first three-and-a-half months of 2014, beating U.S. equities, a performance investors should not necessarily count on being repeated, according to Fran Rodilosso, fixed income portfolio manager for Market Vectors ETFs.
“I see the move in U.S. Treasuries more as short-term rally within the longer-term context of interest rate normalization,” said Rodilosso. “It was also helped along by an unusually harsh winter, which depressed economic activity. But, the Fed has begun to exit a period of extraordinarily easy monetary policy.
However, the path to the door is certainly not well lit, so data will determine the timing, or whether we end up taking more steps backward at some point.”
With this in mind, the Market Vectors ETFs fixed income portfolio manager suggests that longer-term investors may wish to reduce exposure to U.S. interest rates, while avoiding potentially overreaching for yield.
He notes a benign credit environment does not mean corporate bonds are cheap. “I believe there is ample access to capital markets for both high-grade and high-yield issuers; liquidity among borrowers is generally strong and default rates are consequentially low, but valuations in the U.S. high-yield market reflect that good news.”
“Investors may want to consider reducing high-yield exposure to go into higher-quality U.S. credit with shorter duration, even floating rate notes,” Rodilosso said.
“Emerging markets and municipal bonds both were underperformers last year. Despite a generally strong performance in those asset classes so far in 2014, the possibility of yield pickup versus U.S. credit appears to me to be compelling. So, in my opinion, you can give up some yield potential in spots, and possibly add some in others, but a key advantage will be diversifying your exposure to what are perceived as risky assets.”
Mr. Rodilosso has over 20 years of experience trading and managing risk in fixed income investment strategies, including more than 17 years covering emerging markets.