Investors can consider exchange traded funds to help extract higher yields from a bond market that isn’t delivering a lot of topline yield.
In the recent webcast, Active Management for Income: A Better Approach, Jason Greenblath, Vice President, Senior Portfolio Manager, American Century Investments; and Sean Walker, Vice President, ETF Specialist, American Century Investments, outlined the current yield opportunity in the bond markets. For starters, many investors have looked to credit markets to generate more attractive yields.
However, credit spreads have fully retraced 2020 widening and are near historical tights. Corporate credit spreads tightened 11 basis points in 2Q 2021, led by a recovery in dislocated issuers and sectors from 2020. Meanwhile, finance companies outperformed, led by a recovery in Business Development Companies and Airline Leasing companies. On the other hand, Lower beta, tighter spread sectors underperformed, such as Utilities, Telecom and Technology sectors, which are highly rated and offered investors little spread compression.
Looking ahead, the strategists projected a positive trajectory remains for most issuers and sectors. Fundamental factors like deleveraging, re-opening trade, falling default rates, and chip shortages could continue to support the outlook.
In this type of market, spread tightening by any historical measure is very limited from here. The strategists believed that a strong investor appetite leaves new issues concession negligible and spreads tight. Additionally, the U.S. yield advantage for foreign investors should keep demand for the U.S. Credit elevated in the near- to intermediate-term.
Passive bond fund investments have helped investors ride a three-decade-long bull rally, but it will be tougher in the environment ahead. The strategists argued that opportunities are scarce in passive fixed income strategies tied to Bloomberg Fixed Income Indices, and more attractive risk-reward opportunities can be found outside more traditional benchmarks.
Strategies tracking passive indices may expose investors to unforeseen risks, such as credit risk, interest rate sensitivity, market value fluctuations, and a limited investment universe.
Alternatively, investors can consider something like the actively managed American Century Multisector Income ETF (MUSI), which is designed for investors pursuing consistent income in a tax-efficient ETF vehicle. The management team targets attractive yield throughout the market cycle while offering investors access to a diverse opportunity set of securities, including investment-grade corporates, high-yield corporates, emerging market debt, and securitized bonds.
Sector allocation decisions are based on global macro-outlook, historical spreads, and cross-sector valuations and are informed by American Century’s global macro strategy & sector specialist team views. Security selection is led by long-tenured sector specialists who apply fundamental, bottom-up analysis to assess relative value and creditworthiness.
“Continuous and active risk management is a key part of our investment philosophy,” according to American Century.
Additionally, the actively managed American Century Diversified Corporate Bond ETF (NYSEArca: KORP) seeks current income by emphasizing investment-grade debt while dynamically allocating a portion of the portfolio to high yield. KORP adjusts investment-grade and high-yield components to balance interest rate and credit risk. The strategy screens individual credits to seek those with sound fundamentals, reduced default risk, attractive valuations, and liquidity.
The ETF adjusts industry and duration exposures as risks and opportunities emerge. Up to 35% of the fund’s net assets may be invested in high-yield securities or junk bonds. The fund may also invest in derivative instruments such as futures contracts and swap agreements. The weighted average duration of the fund’s portfolio is expected to be between three and seven years.
“Ideas in the portfolio are alpha-generating securities (i.e., rising stars, mispriced relative to our internal views) which we believe offer better risk-adjusted returns,” according to American Century.
Financial advisors who are interested in learning more about yield-generating ideas can watch the webcast here on demand.