While the Federal Reserve has revealed its intent to hike interest rates some time this year, fixed-income yields may remain depressed and bond related exchange traded funds could more room to run.
On the upcoming webcast, Dynamic Fixed Income Strategies for 2016, David Mazza, Managing Director and Head of ETF & Mutual Fund Research at State Street Global Advisors, pointed out that the bond market has been in a bull market for four decades as interest rates fell. While the Fed’s easy monetary policies, which have been a big support for debt markets in recent years, is beginning to fade, other factors can continue to support bonds.
For instance, Mazza noted that increased regulation has forced banks to follow strict capital requirements, which increased the amount of high quality assets on their balance sheets and bolstered demand for Treasuries, keeping a lid on yields.
The aging baby-boomer generation is also exiting the workforce and entering their golden years, raising demand for stable sources of income, like Treasuries and other debt assets.
Meanwhile, overseas central banks have also enacted loose monetary policies that cut interest rates, with some areas adopting negative interest rates to stimulate growth. Consequently, global yield has plunged, with the yield on Bank of America Corp. Global Broad Market Index at 1.3% , its lowest in almost 20 years of data, Bloomberg reports. Consequently, Mazza argued that with the depressed yields in overseas markets, international investors may turn to the relatively more attractive yields in U.S. Treasuries.
“With more than $7.1 trillion of government debt yielding less than zero, investors searching for income have turned to Treasuries,” Mazza said.
Lastly, a strong U.S. dollar and low inflation expectations makes U.S. assets, like Treasury bonds, enticing. High inflation would typically erode the value of fixed-rate payments over time.
[related_stories]However, Mazza advises advisors to look beyond bond benchmarks like the Barclays Aggregate Bond Index to improve diversification from low correlations found in other bond categories. The benchmark leaves most investors heavy on U.S. Treasury bond exposure. Moreover, investors may be missing out opportunities in municipal bonds and Treasury inflation protected securities as the Aggregate Bond Index does not include either categories. Mazza pointed other options like U.S. convertible bonds with a -0.05 correlation to the Aggregate Bond Index, U.S. leveraged senior loans with a -0.02 correlation, U.S. 1-5 year floating rate notes with a 0.05 correlation, liquid high yield with a 0.21 correlation, and emerging market sovereign debt with a 0.56 correlation.
Investors can also tap into these debt markets through targeted bond ETF options, including the SPDR Barclays Convertible Securities ETF (NYSEArca: CWB), SPDR Blackstone/GSO Senior Loan ETF (NYSEArca: SRLN), SPDR Barclays Investment Grade Floating Rate (NYSEArca: FLRN), SPDR Barclays High Yield Bond ETF (NYSEArca: JNK) and SPDR Barclays Emerging Markets Local Bond ETF (NYSEArca: EBND).
K. Sean Clark, Chief Investment Officer of Clark Capital Management Group, also mirrored Mazza’s sentiment that the changing bond environment could call for a broader set of fixed-income tools. For instance, Clark Capital Management recently trimmed its holdings of long-term and intermediate Treasury bonds after the run-up in favor of junk bond holdings, like JNK. JNK and the junk bond market have been under pressure and offer attractive valuations after the risk-off selling.
However, Tim Anderson, Chief Fixed Income Officer of the RiverFront Investment Group, warned of increased default risks in the speculative-grade debt market this year. Alternatively, Anderson believes intermediate corporate bond yields look attractive as spreads have significantly widened and negative interest rates overseas will push more foreign investors into investment-grade U.S. corporates.
ETF investors can look to the SPDR Barclays Intermediate Term Corporate Bond ETF (NYSEArca: ITR) for exposure to intermediate-term, investment-grade corporate debt.
Financial advisors who are interested in learning more about ETF strategists’ fixed-income strategies can listen to the webcast here on demand.