As investors take an overhead view of the global fixed-income landscape, many are taking into account the changing market conditions and adapting to the changes by creating a diversified bond portfolio.
In the recent webcast, Insights for a Modern Fixed-Income Portfolio, Gary Stringer, President and Chief Investment Officer, Stringer Asset Management, LLC; Josh Rohauer, Portfolio Manager, Horizon Investments; and Bill Ahmuty, Head of SPDR ETF Fixed Income, State Street Global Advisors, outlined the current market conditions and pointed out a more selective approach to the various bond markets.
Global central banks are looking to reverse some of the tightening policies put in place over the past two years as the global economy slows. Growth has weakened in most major economies and financial conditions have tightened going into 2019 as investors grew increasingly concerned about the end of the post-crisis economic expansion that has extended for a decade.
Consequently, long-term rates fell moderately in response to the weaker growth outlook and a more dovish policy path, contributing to a flatter yield curve. Meanwhile the U.S. dollar depreciated against most major currencies as the Fed’s flatter policy path moves it more in line with that of the European Central Bank and Bank of Japan.
Many are now worried that the fixed-income markets may be signalling an economic recession around the corner after the recent inversion of the 3-month to 10-year Treasury spread.. Yield curve inversions have preceded U.S. recessions by one to three years. Consequently, investors should expect increased near-term volatility.
This is particularly worrisome given the trends in the fixed-income investment landscape. U.S. fixed-income ETF assets have grown to $657 billion since the inception of the first bond ETF in 2002, representing 40% asset growth per year on average. The majority of assets have flowed into U.S. government and so-called Aggregate bond index funds. However, more recently, fixed income ETFs saw their highest ever first quarter inflows as investors have piled money into high yield and mortgage-backed debt. After coming under pressure in 2018, bond segments have broadly rallied over the first three months of the year, with credits and emerging markets strengthening amid falling yields.
Traders, though, are cognizant of the potential interest rate risks and have heavily tilted toward short duration debt as a way to mitigate rate risk – duration is a measure of a bond fund’s sensitivity to changes in interest rates so a low duration corresponds with a low sensitivity.
Investors can look to credit related bond ETFs to access attractive yield opportunities, including, the SPDR Portfolio Intermediate Term Corporate Bond ETF (NYSEArca: SPIB) and the SPDR Portfolio Short Term Corporate Bond ETF (NYSEArca: SPSB) for a lower rate risk profile.
The SPDR Barclays High Yield Bond ETF (NYSEArca: JNK), the second-largest high-yield corporate bond exchange traded fund, has been attracting heavy investment interest as a way to generate high yields in this return to low-yield environment. Investors who are concerned about rate risk may even consider something like the SPDR Bloomberg Barclays ST HY Bd ETF (NYSEArca: SJNK), the shorter duration counterpart to JNK.
The SPDR Bloomberg Barclays Emerging Markets Local Bond ETF (NYSEArca: EBND) may also help investors diversify into the global markets and tap into the higher yield opportunities in the developing economies. The stabilizing dollar outlook also diminishes the danger of taking on emerging currency exposure, which has historically acted as a large source of volatility for investors investing in local-currency-denominated emerging market debt.
The SPDR Blmbg Barclays Investment Grade Floating Rate ETF (NYSEArca: FLRN) can also be used as an alternative for investors worried about rate risk. Floating rate notes, like the name suggests, have a floating interest rate. Specifically, the notes’ have a so-called reset period with interest rates tied to a benchmark, such as the Fed funds, LIBOR, prime rate or U.S. Treasury bill rate. Due to their short reset periods, these floating rate funds have relatively low rate risk.
Financial advisors who are interested in learning more about fixed-income strategies can watch the webcast here on demand.