The fixed-income market has enjoyed a record run as yields declined over the past three decades, but we are looking at a rising rate environment ahead. Consequently, bond investors can look to a number of alternative exchange traded fund strategies to help ease the transition.
In the How to Tackle Yield in Today’s Fixed Income Environment panel on the annual online ETF Trends Virtual Summit (available on-demand for up to 4 CE Credits), Martin Kremenstein, Managing Director and Head of ETFs at Nuveen, Fran Rodilosso, Head of Fixed Income ETF Portfolio Management at VanEck, and Eric Ervin, President & CEO of Reality Shares, outlined three possible economic outcomes ahead: The markets lift off and we continue on pace for another record year. The markets experience engine failure and we head toward a reversal. Alternatively, there is low visibility and we are in for volatility.
Ervin warned that fixed-income market has already enjoyed a three-decade bull run as bond interest rates have pushed lower and lower since the 1980s, which has caused fixed-income investors to look for alternative ways to bolster their bond portfolios.
The demand for yield will never go away, especially as we have a generation of baby boomers entering their retirement years, improved health care that is extending life spans and an increasingly greater amount of those entering retirement with debt.
However, Kremenstein warned of the risks that fixed-income investors are currently exposed to, especially those tracking the benchmark Bloomberg Barclays U.S. Aggregate Bond Index. The Barclays Agg held 25% Treasuries, 15% government-related debt, 20% corporates and 40% securitized debt at the end of 2005, but the Index now holds 36% Treasuries, 8% government, 26% corporates and 30% securitized. The benchmark’s exposure has in turn increased the index’s duration and lowered yields, which pose significant risks if rates rise.
In an attempt to make up for the risks that the Barclays Agg now exposes investors to, Nuveen recently launched the NuShares Enhanced Yield U.S. Aggregate Bond ETF (NYSEArca: NUAG) as alternative to traditional aggregate bond funds. NUAG seeks to offer enhanced yield relative to the broad, investment-grade fixed income market with comparable risk and credit quality.
Rather than weighting by capitalization, the Enhanced Index assigns component securities into a variety of categories based upon asset class, sector, credit quality, and maturity, and then uses a rules-based methodology to allocate higher weights to categories with the potential for higher yields without significantly increasing risk or decreasing credit quality.
Rodilosso also argued that higher yields could be one way to cushion against potential volatility.
“Additional carry provides protection from underperformance and stability amid rising rates and currency volatility,” Rodilosso said. “Low yields make core fixed income sectors highly vulnerable to rising rates.”
Investors can look to overseas assets or corporate debt to bolster yield generation. For example, investors have a number of ways to gain exposure to the high yielding emerging bond market, such as the broad VanEck Vectors Emerging Markets Aggregate Bond ETF (NYSEArca: EMAG), VanEck Vectors J.P. Morgan EM Local Currency Bond ETF (NYSEArca: EMLC) and VanEck Vectors Emerging Markets High Yield Bond ETF (NYSEArca: HYEM). EMAG has a 4.26% 30-day SEC yield, EMLC has a 5.81% 30-day SEC yield and HYEM has a 5.76% 30-day SEC yield.
Fixed-income investors can gain exposure to corporate debt through options like the VanEck Vectors International High Yield Bond ETF (NYSEArca: IHY), which has a 4.08% 30-day SEC yield, and VanEck Fallen Angel High Yield Bond ETF (NYSEArca: ANGL), which has a 4.92% 30-day SEC yield.
Additionally, Ervin pointed to the actively managed Reality Shares DIVS ETF (NYSEArca: DIVY) as a good alternative for a conservative fixed-income position in a changing market environment.
“Isolated dividend growth is a fixed income replacement offering capital appreciation potential while historically delivering low correlation and low drawdowns across a variety of market environments,” Ervin said.
DIVY tries to provide exposure to the growth rate of expected dividends and looks to deliver long-term capital appreciation rather than income and yield through options contracts and dividend swaps.
“Because DIVY was designed to have a lower volatility than the S&P 500 while exhibiting higher returns than bonds, it serves as a potentially effective replacement for part of your bond portfolio allocation,” Ervin added.
Financial advisors who are interested in learning more about CFP/CIMA accredited panels on the online conference can watch the 2017 ETF Trends Virtual Summit on demand.