Fixed-income investors should look to fixed income strategies like corporate credit and mortgage-backed securities-related exchange traded funds that can help better adapt to rapidly changing market conditions.
In the recent webcast, Why Corporate Credit and Mortgage-Backed Securities Can Prosper in Rising Rate Environments, Ryan Wellman, ETF product manager at John Hancock Investments, noted that while markets have pulled back, they haven’t retreated enough to rival previous declines. Equities still aren’t cheap and current valuations are based on the best corporate margins/highest earnings in history. Additionally, looking ahead, he argued pointed out that the chart of starting price-to-earnings and subsequent 10-year annualized price return on the S&P 500 suggested a 4% to 6% price return from here on out.
Meanwhile, in the fixed-income market, Wellman argued that the big taxable bond outflows of $39 billion in May and $100 billion in total to start the year could be setting up another buying opportunity. Historical big taxable bond outflow periods of 2008, 2013, and 2018 all preceded periods of strong bond returns.
Wellman also said that the dispersion of returns following yield curve inversions calls for a focus on quality. For example, core bonds, such as mortgage-backed securities and investment-grade corporates, have historically outperformed other bond market segments after a yield curve inversion. Consequently, he advised that careful asset class selection in credit may lead to favorable risk/reward trade-offs.
“Historically, higher quality bonds – including MBS, munis, and investment-grade corporates — have demonstrated solid performance following periods of stress,” according to Manulife Investment Management.
Peter M. Farley, senior portfolio manager at Securitized Assets, Manulife Investment Management, argued that securitized markets are large and segmented, providing exploitable inefficiencies that investors can capitalize on. The securitized market offers potentially attractive relative value characteristics as it features risk-efficient, senior-enhanced securities, and the lack of transparency can cause securities to price below intrinsic value. Additionally, some types of securitized assets react positively to rising rates.
Furthermore, Farley believed that the record low supply of housing could offset the impact of higher mortgage rates ahead. Higher mortgages are expected to cause home price appreciation to decelerate. Record low inventory numbers should limit the impact of higher rates on valuations. Existing homeowners could opt to stay locked into their current low rate, further exacerbating the supply/demand imbalance. Despite higher mortgage rates, home price appreciation has remained positive in this cycle and previous rate hike cycles.
As a way to access this market, investors can look to the John Hancock Mortgage-Backed Securities ETF (JHMB), which is sub-advised by Manulife Investment Management (US) LLC, a John Hancock Investment Management-affiliated asset manager.
The strategy is backed by an experienced collaboration combining the U.S. core and core plus fixed income team with the expertise of the securitized assets team and grounded in the deep research capabilities of Manulife. The investment team is exclusively responsible for all investment decisions related to the strategy. Security selection and sector allocation are primary drivers of relative performance. The strategy is focused on income generation through mortgage-backed securities and complementary securitized exposure. Furthermore, extensive modeling capabilities and resources are used for stress testing and scenario analysis. The team focuses on volatility management through a diversified portfolio that is balanced between high-quality agency mortgage-backed securities and other securitized fixed income.
“We believe securitized assets offer interesting sourcing opportunities due to information barriers and limited competition in a large, inefficient marketplace. The portfolio is managed with a value orientation and a focus on diversification among securitized asset classes, income generation as a consistent component of total return, and maximizing risk efficiency,” Farley said.
Looking at the corporate credit markets, Pranay Sonalkar, portfolio manager at U.S. Core and Core Plus Fixed Income, Manulife Investment Management, argued that security selection can add value in a rising rate environment, so an active touch in bond strategies may be a better approach than traditional indexing. For example, active management in securitized markets can provide attractive yields per unit of duration.
John Hancock Investment Management LLC has come out with the John Hancock Corporate Bond ETF (JHCB) to help investors better access the corporate bond landscape. The ETF was the first fixed income ETF advised by the firm and is sub-advised by Manulife Investment Management (US) LLC, John Hancock Investment’s affiliated asset manager.
The John Hancock Corporate Bond ETF is actively managed and seeks a high current income level consistent with prudent investment risk. Under normal market conditions, it invests at least 80% of its net assets (plus any borrowings for investment purposes) in corporate bonds.
JHCB’s active managers also navigate the lower quality segment of the IG corporate bond market to provide a higher yield.
“We believe strong relative performance can be generated through bottom-up active management of industry allocation and issue selection, combined with yield curve positioning. Our disciplined investment process seeks to add value by following a relative value approach to sector allocation and issue selection, engaging in intensive fundamental credit research, and identifying points on the yield curve with the greatest return potential,” Sonalkar said.
Financial advisors who are interested in learning more about these fixed-income strategies can watch the webcast here on demand.