Inflows into passive funds hit a high in the month of June, but global investment firm J.P. Morgan is recommending to fixed income investors that being active could help de-risk a portfolio’s bond exposure.
This is especially true when looking at passive strategies that incorporate BBB bonds–the lowest-rated investment-grade debt, which could slip into a default bonanza if the market experiences a sharp downturn.
“If you look at the composition of the corporate credit market, it is really tilted toward lower quality investment grade — what we would call a lot of BBB-rated credit,” said J.P. Morgan Asset Management Head of Global Investment Grade Corporate Credit, Lisa Coleman. “When one invests in a passive strategy you get just the market weightings of things.”
According to the latest Morningstar report for U.S. mutual fund and exchange-traded fund (ETF) fund flows, passive funds notched their best month year-to-date during the month of June with inflows of $69 billion across all category groups. The market share for passive funds now accounts for 40 percent compared to a year ago when it was 37.4 percent.
The Federal Reserve has been putting its more dovish side on display, which pivots from 2018’s rate-hiking bonanza. In addition, fixed income investors are facing other challenges like inverted yield curves and signs of slowing global growth.
Given these challenges, how do investors approach the bond markets? One of the ways is via actively-managed bond ETFs like 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.
SEIX will be subadvised by Seix Investment Advisors LLC, which will manage investments for the portfolio with a management fee of 0.57 percent.
With 2018’s year-end sell-offs in U.S. equities, investors are giving value investing a closer look in 2019. A byproduct of a shift to value is a focus on the quality of investments–being selective and using due diligence as screeners to find the best-performing investments.
One corner of the bond market that especially saw an influx of capital was short duration bonds and USI provides this benefit 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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