Virtus ETF Solutions
Floating-Rate Bank Loans Offer Natural Hedge to Rising Interest Rates
Investors appear ready to embrace an exuberant 2017, with a lot of hope—and money—riding on expectations for economic growth, spurred on by hoped-for tax cuts and infrastructure spending that are within reach of a unified U.S. Congress and White House. Yet the potential risks ahead are not insubstantial. They include rising inflation, a growing debt burden and a possible trade war resulting from a push toward protectionism.
Preparing to be a nimble, flexible investor might be the best—certainly a more prudent— approach in 2017, according to Virtus ETF Solutions.
The company, an affiliate of Virtus Investment Partners, differs from most other ETF issuers in that it’s a multimanager ETF sponsor. That is, Virtus offers access to subadviser investment teams, each of which focuses on its own specific area of expertise. For example, its Newfleet Asset Management affiliate focuses on fixed-income strategies. Other Virtus ETF subadvisers include Infrastructure Capital Management and Reaves Asset Management.
According to Virtus, the post-election stock-market euphoria suggests a need to keep emotions in check. Take the enthusiasm around the prospect of infrastructure investment—that eagerness should be tempered. “The market is acting like the companies already have shovels in hand,” says Dave Albrycht, president and chief investment officer of Newfleet Asset Management.
Here’s what investors are failing to realize: It may be 2018 before anyone sees the results of any federal infrastructure or fiscal-stimulus efforts, and it’s still unclear which companies will benefit directly. Investors should keep in mind that the market may start to rationalize its outlook long before then—and financial advisers should communicate the potential risks and rewards with their clients.
Another risk, one that’s been heralded for years and now, finally, appears underway, is the prospect of rising interest rates. How can financial advisers best serve their clients’ fixed-income needs in a rising-rate environment? Maneuverability might be the best solution to consider—specifically, the ability to pivot in and out of different sectors of the credit markets in anticipation of market-moving events.
For example, floating-rate bank loans offer a natural hedge to rising interest rates. They pay interest at a variable rate set at the Libor rate plus a spread. “If rates continue to rise, or more specifically, Libor continues to rise, your coupon will reset higher every 90 days,” Albrycht points out. “As a result, bank loans historically have exhibited very minimal interest rate risk and have performed very well during rising-rate environments. If you are of the belief that the Fed will hike rates two to three times in 2017, then this is an asset class to consider owning.”
Then there’s high-yield corporate debt: it, too, can provide a protection from rising interest rates, in part because higher rates signal a growing economy, which tends to mean higher company profits, thus better debt servicing and fewer defaults. But there’s high-yield—and then there’s high-yield. It’s a “bifurcated market,” Albrycht says. About 20% of the market—energy, chemicals and metals and mining—has caused most of the volatility over the last couple of years. Thus, financial advisers looking to ease their clients’ rising-rate fears through high-yield corporate debt need to move carefully. Again, being nimble is key.
One clear signal of Virtus’s focus on flexibility in the fixed-income space is the new ETF it unveiled with Newfleet in December: the Virtus Newfleet Dynamic Credit ETF (ticker: BLHY), which gives its managers the ability to allocate as they see fit between high-yield corporate debt and floating rate bank loans, both of which have low correlation to core fixed income—yet still jump 100% into Treasuries if conditions suggest it. That type of maneuverability and ability to take an opportunistic approach to leveraged finance could be key to make the most of any volatility that lies ahead.
The importance of treading carefully isn’t reserved solely for the high-yield debt market. Another area where investors may want to go, but may not always weigh the risks carefully enough, is ex-U.S. developed markets, as well as emerging markets. Choose carefully. The variance in the total return performance between the best- and worst-performing countries was about 70% in 2016. “You’ve got to pick the right countries, and in those countries, if you make the right bet, you have to pick the right companies. And then you have to make the determination as to whether you want currency exposure,” Albrycht says.
Meanwhile, there is some good news to consider: The U.S. economy is showing signs of strength. The housing market is stabilized and starting to grow in line with wage growth. Plus, consumer fundamentals, which have been an area of strength for the economy, are stable. That’s good for structured debt, including asset-backed securities and commercial mortgage securities.
Virtus ETF Solutions, formerly ETF Issuer Solutions, an affiliate of Virtus Investment Partners, operates a multimanager ETF platform, providing investors access to differentiated investment capabilities from select subadvisers.
Newfleet Asset Management LLC, a provider of fixed-income investments, is a wholly-owned affiliated manager of Virtus Investment Partners.
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