Investors may also consider integrating certain sectors, like the three below, which help diversify a portfolio’s interest rate risk profile while not sacrificing yield in a rising rate environment:
- Short-term investment-grade floating-rate notes that have coupons that float with short-term interest rates, such as LIBOR
- Senior secured loans that feature a low duration profile and floating yields
- Higher-yielding debt such as high-yield corporate bonds
Investors who can bring high yield and senior loans inside the “new core,” while carefully considering how higher credit risk in one part of the portfolio can be offset with exposures to less-credit-sensitive sectors, such as investment grade floating rate notes, elsewhere, we believe are more likely to achieve a desired balance.
A hypothetical portfolio
The figure below shows how these various elements can be brought together in a forward-looking “Expanded US Aggregate Portfolio.”
Using ETFs as the building blocks of the portfolio gives investors an efficient way of accessing the underlying asset classes. It can also substantially lower transaction costs compared with buying individual bonds. In less liquid sectors like high yield or senior loans, the liquidity of ETFs greatly narrows bid/ask spreads that can hinder do-it-yourself bond managers.
This illustration shows how investors can potentially provide improvements in yield at lower duration risk relative to the Agg.
Source: Bloomberg, State Street Global Advisors, as of 6/30/2015. Past performance is not a guarantee of future results.
For standard performance data of each underlying ETF please click here.
The takeaway for bond investors
Many of the common fixed income tactics and allocations of the past 30 years may no longer be desirable, and a simple buy-the-Agg-and-hold approach might not be best in today’s changing environment.
Expanding fixed income sector allocations while staying central with a truly diversified portfolio may help investors build a portfolio that seeks to deliver yield without taking on too much additional risk. And with the low-cost precision of ETFs, investors now have the tools needed to reconstruct a core that is well positioned for the market’s cycles.
To learn more about taking a new approach to your core fixed income portfolio, read my full report Fixed Income: The Tide May be Turning.
1Bloomberg, as of 6/30/2015
2Barclays, State Street Global Advisors, as of 6/30/2015
David Mazza is a Vice President of State Street Global Advisors and the Head of Research for SSGA’s ETF and mutual fund businesses.