Fixed Income Investing in Today's Market Environment | ETF Trends

ETF Trends caught up with Gene Tannuzzo, deputy global head of fixed income at Columbia Threadneedle Investments and portfolio manager for the Columbia Diversified Fixed Income Allocation ETF (DIAL), to get his take on fixed income investing in today’s market environment.

What are your current views on the fixed income market?

We’ve seen aggressive action from the Federal Reserve and global central banks to move interest rates back down to 2008 levels and inject capital into money markets. We’ve also seen Congress take significant steps to provide fiscal stimulus with the CARES Act and other recent legislation. While the economic impact will be material in the near term, it will take time to show up in the broad economic dataset.

U.S. interest rates have followed the path of global interest rates to historically low levels, but they remain positive. At this point, we expect the fed funds rate to be anchored at 0.00%–0.25% for an extended period given the shock and magnitude of the current situation. U.S. Treasury yields with longer maturities are currently trading in a range around 1.00%, which seems reasonable. The economic slowdown and relative level (higher) of U.S. rates globally should limit an upside move in yields for intermediate and long maturities

At the beginning of 2020, high quality over low quality bonds was one of our investment themes – and we reemphasize that theme now. Low quality bonds will be challenged by higher default rates in sectors such as high yield, bank loans and emerging market bonds. High yield valuations are back to early 2016 wides. At these levels, we would estimate that the market is pricing in a “normal recession” (i.e., not a financial crisis) including default rates around 9%. We believe that this is starting to provide fair compensation for expected higher defaults. But the big unknown is: will this be “normal?”

What should investors be thinking about?

During these uncertain times, it is critical to keep in mind the importance of diversification – yes, among sectors, but also product type and risk levels. Achieving yield, particularly in today’s declining rate environment, would require a significantly riskier portfolio – and that level of risk isn’t appropriate for most investors.

Additionally, credit spreads have reached levels seen few times before. Historically, when investors have invested in credit at these levels, returns over a 12-month horizon have been quite positive. It can pay to have a longer time horizon.

Where are you seeing opportunities?

In the short run, challenging liquidity conditions can exaggerate price moves. However, opportunities are emerging. Historically, markets turn well in advance of the improvement in economic data. We’re closely watching data related to new virus cases that could suggest the worst is over, combined with the policy response to help get the economy back on its feet. When investors believe the worst is over, sentiment and prices could rebound quickly.

In the current market, we believe high-quality assets, including investment-grade corporate bonds and structured assets, are the proverbial baby getting thrown out with the bath water. While volatility has risen, we believe the risk premiums compensate well for risks in high-quality assets.

Overall, we think this could present a buying opportunity, but we’re measured in our approach to adding risk, because we believe it will still take some time until we have clarity on the resolution to COVID-19. Our approach is to be safe but stay invested. Prices may move lower in the near term, but already reflect a “normal” recession, which seems fair for long-term investors.

How can investors use ETFs to capitalize on those opportunities?

Finding income in today’s low interest rate environment can be extremely challenging to manage without increasing risk. Our view is to hold a diversified, thoughtfully constructed portfolio aimed at managing risk.

The Columbia Diversified Fixed Income Allocation ETF (DIAL) is a solution that aims to deliver enhanced return and yield opportunities in one fund. DIAL is a low-cost solution that is diversified across six fixed-income sectors and rebalances monthly to help portfolio managers sell appreciated sectors and buy lagging sectors. The fund is a top performer in its U.S. Multisector Bond category across mutual funds and ETFs. DIAL may be used as the core of a portfolio or as a complement to help with cost reduction, managing volatility and broadening diversification.

For more information on DIAL, click here.