While the economy is still continuing to expand, risks are rising. With many expecting a rising interest rate environment, bond exchange traded fund investors should be thinking about ways to mitigate the risks ahead.
On the recent webcast (available on-demand for CE Credit), PIMCO’s Fixed Income Strategy for 2017, Jerome Schneider, Head of Short-Term Portfolio Management at PIMCO, pointed out that since the elections, the markets have focused on inflation and pro-growth potential.
Consequently, many anticipate the Federal Reserve will raise interest rates to head off an overheating economy, which will weigh on bond markets.
Alternatively, investors can turn to active management for capital preservation and volatility reduction, Schneider said. For example, an actively managed bond portfolio can utilize active yield curve management to dampen overall volatility attributed to interest rate risk and target attractive names or sell names after they reach fair value to adjust credit risk.
Moreover, given the reforms in the money market segment as regulators try to obviate another Lehman Brother’s event, an active ultra-short-duration bond strategy is essential to maintaining purchasing power preservation in the post money-market reform world, Schneider added.
With the current market risks, PIMCO suggests that the most effective “shock absorbers” are derived from liquidity premiums, curve positioning and credit spread, whereas factors like duration and currency are among the largest contributors to portfolio volatility.
For example, after the extended fixed-income bull market, Schneider suggested that BBB-rated corporate credit provides improved risk-adjusted returns, compared to higher quality debt.