Propping up the rally in the government bonds and fixed-income-related exchange traded funds, Corporate America has been adding Treasuries and mortgage-backed securities onto their corporate portfolios in anticipation of potential volatility ahead.
In an attempt to hedge risks associated with a struggling Eurozone and potential Federal Reserve policy changes that could weigh on corporate earnings, corporate bond portfolios have increased U.S. government debt allocations by 15% this year through September, compared to a 6.5% rise for the same period last year, reports Tim McLaughlin for Reuters.
Corporate bond funds usually hold a range of debt and other conservative assets, including mortgage-backed securities, U.S. Treasuries and bonds backed by student loans, credit cards and auto loans.
The greater interest in Treasury debt indicated that corporate money managers expected growing volatility. Consequently, the surge in corporate interest for government debt has helped fuel a rally in Treasury bonds and related ETFs. Year-to-date, the iShares 7-10 Year Treasury Bond ETF (NYSEArca: IEF) has increased 8.5% while theiShares 20+ Year Treasury Bond ETF (NYSEArca: TLT) jumped 21.2%. [Volatile Market Sends Investors to Some Familiar ETFs]
Mortgage-backed security ETFs have also strengthened. Year-to-date, the iShares MBS ETF (NYSEArca: MBB) is up 5.7% and Vanguard Mortgage-Backed Securities Index ETF (NYSEArca: VMBS) is 5.2% higher.
Meanwhile, economic weakness ahead could translate to lower earnings and weigh on corporate debt securities.
Matt Toms, head of fixed income at Voya Investment Management, has been buying mortgage-backed securities while cutting down on corporate bonds. Toms argues that financial companies are exposed to the weakness in Europe. In contrast, mortgage-backed securities focus on the U.S. economy and are backed by the improving U.S. housing market. Toms, who runs the Voya Intermediate Bond Fund, has almost two-thirds of his portfolio assets in government bonds or government-related securities.
Michael Salm, co-head manager at Putnam Investments, believes that the falling oil prices could translate to higher corporate defaults among junk-rated energy companies.
Additionally, some fixed-income observers are growing concerned about liquidity in the corporate bond market where new regulations and capital requirements since the financial crisis forced Wall Street banks to cut their inventories, which has significantly reduced the number of matching buyers and sellers.
“Everyone sees the lack of liquidity as a potential risk in the corporate bond market,” Sumit Desai, the lead analyst for corporate credit funds for Morningstar, said in the article. “But there hasn’t been a major event to test the market.
Year-to-date, the iShares iBoxx $ High Yield Corporate Bond ETF (NYSEArca: HYG) and the SPDR Barclays High Yield Bond ETF (NYSEArca: JNK), the two largest junk bond ETFs by assets, increased 3.9% and 3.6%, respectively. The iShares iBoxx $ Investment Grade Corporate Bond ETF (NYSEArca: LQD), which tracks investment-grade debt, gained 7.8% so far this year.
For more information on the fixed-income market, visit our bond ETFs category.
Max Chen contributed to this article.