The bond market is rife with opportunities, especially in the ETF world where fixed income funds are having another record year, but when volatility strikes, this is where active management can play a crucial role.
“The bond market is not a market to invest in a passive way,” said Jeffery Elswick, director of fixed income at Frost Investment Advisors. “There’s a lot of opportunities if you’re an active manager.”
If interest rates were to move higher in 2020, this is when Elswick sees active management as almost a necessity. With the flexibility to move in and out of debt issues quickly to adjust for changes in the market, active management has a leg up on passive.
“You’re going to have returns that are pretty ugly, and so active managers usually do better in that type of environment,” Elsick added.
A pair of active ETFs worth looking include the Virtus Seix Senior Loan ETF (NYSEArca: SEIX) and Principal Ultra-Short Active Income ETF (NYSEArca: USI).
SEIX seeks to provide investors with a high level of current income via first- and second-lien senior floating rate loans. Senior loans are typically used for business recapitalizations, acquisitions, leveraged buyouts, and re-financings.
The inherent risks associated with senior loans are similar to the risks of junk bonds, but have seniority in the event of borrower default so if the business is forced to sell its assets in a liquidation scenario, the senior loan will be paid first. In addition, senior loans are secured by assets whereas junk bonds are not, making them a more attractive investment option when constructing a loan portfolio.
SEIX will invest in loans that contain possess floating coupon rates tied to a benchmark lending rate, and are below investment grade or unrated. The floating rate allows investors to capitalize on any short-term interest rate adjustments.
Another corner of the bond market to look at is short duration bonds and USI provides this exposure while at the same time, has the active management component. USI will invest in debt issues that seek to maintain both an average effective maturity of three years or less, and an average portfolio duration of one year or less.
USI may hold a mix of fixed and floating rate securities in U.S. and foreign debt from the financial services sector, such as banking, insurance and commercial finance. USI will be managed by Principal Global Advisors–an indirect subsidiary of Principal Financial Group with a cost-effective fee of 0.18 percent.
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