The month of October wasn’t only a signal to stock investors that due diligence is necessary when screening for quality U.S. equities that can be resilient during times of volatility, but it also put fixed-income investors on notice that the same strategy is necessary for the bond market. One emerging theme that rose out of the volatile October was a need for more short duration exposure as external headwinds face fixed-income markets going forward.
External Headwinds for Fixed Income
A combination of rising interest rates, a healthy injection of government debt into the markets and other external factors has made for a more intricate bond market. If the sell-offs in October portend that the decade-long bull run may be exiting out of its late market cycle, then the environment for fixed-income investors will only get more complex.
“New cross-currents created by historic injections of central bank liquidity – as well as by demographics, technology, and regulation – have made it more complex,” an article in Institutional Investor noted. “A transition is under way as monetary policy normalizes, liquidity ebbs, and bouts of volatility are roiling the market. The implications for fixed income investors are significant.”
Short Duration Options
October saw Treasury yields climbing in addition to rising interest rates, causing investors to flock to shorter-duration debt issues as opposed to those with longer maturities–this forces fixed-income investors to be more diligent in their debt investments by looking into other areas of the bond market as opposed to broad exposure–such as short duration bond exchange-traded funds (ETFs).
“We expect rising rates to cause tighter liquidity and increase dispersion, which will create opportunities to generate alpha,” said James Keenan, Chief Investment Officer and Global Co-Head of Credit. “We recommend positioning for this shift by moving up in quality and reducing duration. This will help to mitigate against unintended, idiosyncratic risks, and interest rate uncertainty.”
With the short-term rate adjustments being instituted by the Fed, investors can limit exposure to long-term debt issues and focus on maturity profiles. An example would be the SPDR Portfolio Short Term Corp Bd ETF (NYSEArca: SPSB), which seeks to provide investment results that correspond to the performance of the Bloomberg Barclays U.S. 1-3 Year Corporate Bond Index.