Thought leaders and portfolio managers across the industry weighed in on the direction of fixed income investments during the Q3 Fixed Income Symposium hosted by VettaFi.
Rate Expectations & Benefits of Preferred Securities
With all eyes on the Federal Reserve, when should we expect to start seeing interest rates get cut down? And if inflation is starting to get under control, what should investors expect to see from fixed income strategies?
To understand the economic environment we find ourselves in, Brenda Lagenfeld, CFA, portfolio manager at Nuveen, looked at a number of macro factors, including GDP, inflation data, and the labor market. She noted that these factors are currently presenting support for cutting interest rates.
“Nuveen’s base case remains to be expecting a soft landing, and we don’t currently see anything in recent data that seems to threaten that expectation,” Lagenfeld added.
As for the current investment case for fixed income, Lagenfeld noted that investors should lock in yields in a timely matter. This is because “the market will likely move in anticipation of the easing in a greater degree than when the cuts do actually happen,” she explained.
In terms of specific assets to look at, Lagenfeld cited senior loans and high yield corporate securities. These options in particular have seen strong performance, and issuers have been able to refinance very successfully, according to Lagenfeld.
She also highlighted preferred securities as an attractive investment option. Lagenfeld added that “banks are fundamentally resilient,” supported by robust capital levels.
To help manage the complex structural features of preferred securities, she recommends using an active approach. By investing in an active strategy, portfolios can gain access to a more diverse selection of preferred segments.
Compared to other fixed income offerings, Lagenfeld noted that preferred securities aren’t seeing the same headwinds that investment-grade credit may be seeing. For now, the fundamentals for the security option remain sound and strong.
Momentum of Active Management
Day after day, asset managers continue to innovate by bringing new active fixed income ETFs to the market. With these products gaining popularity, how can advisors best use these funds for investor portfolios?
Michael Plage, CFA, portfolio manager at Fidelity Investments, highlighted three market drivers active managers in the bond space should be considering. In particular, these drivers are inflation, employment data, and the Federal Reserve’s response to both inflation and employment data.
As Plage noted, the Federal Reserve’s decisions have continued to drive the direction of the fixed income market. Investors should expect that to continue to be the case going forward.
On expectations for interest rate shifts, he did not expect a cut in July, because “the last thing the Fed wants to do is surprise the market.” Instead, Plage noted that the market is expecting a rate cut to occur in September, with a December rate cut remaining possible as well.
No Slowdown in Trend on Horizon
Over the last 10 years, Plage observed that interest in active ETF products, including fixed income, continues to grow. “The momentum in active and the momentum in ETFs has really picked up quite a bit in 2024,” he added. Looking ahead, Plage does not expect this trend to slow down.
Comparing active bond strategies to passive options, he noted that the bond market is far wider than many of the indexes that passive strategies replicate. Therefore, active can fish in a larger pond of bond assets, with the added benefit of using personal judgment to decide which sectors to focus on. In doing so, opportunities arise for active bond strategies to outperform their passive peers.
While active strategies used to come with the downside of high fees, Plage noted that many fees have dropped considerably. With lower fees and higher outperformance potential, he observed the trend supports growth of active strategies: “Clearly, there’s been a movement from passive to active over time.”
The Fidelity Investment Grade Bond ETF (FIGB) can work for investors as a low-risk core strategy. The fund is tied well to its benchmark in terms of investment-grade options and portfolio duration.
As one of Fidelity’s flagship products, the Fidelity Total Bond ETF (FBND) offers a core strategy with a smaller selection of high yield options. This fund allows investors to access the benefits of the Agg, along with higher returns and potential outperformance.
The Fidelity Tactical Bond ETF (FTBD) is a flexible option, offering stronger exposure to high yield securities along with tools to outperform. This fund can serve as a good means to diversify a portfolio.
Managing Interest Rate Risk
Consensus is mounting that interest rates should come down about a year from now. With that in mind, investors will need to consider how much interest rate risk that they are willing to take on.
Nancy Davis, Quadratic Capital founder and portfolio manager, notes that the market consensus is that the Federal Reserve has managed to beat back inflation. With the market pricing future inflation around the 2% level, Davis sees the current environment as a good time to bolster a diversified core fixed income portfolio.
Good Time to Get Real Yield
“Real yields have not been this high in a decade, so it’s a really good time to get that real yield, as well as he inflation side of the bond market,” she added.
With rate volatility weighing on investors minds, Davis noted that rate volatility has fallen dramatically. Despite the market’s expectations of more rate cuts this year, fundamental catalysts have kept volatility on the lower side.
For investors seeking more inflation protection, the Quadratic Interest Rate Volatility & Inflation Hedge ETF (IVOL) can help. The fund primarily invests in treasury inflation protected securities.
IVOL can give investors a new avenue to profit from inflation, should the yield curve steepen, or rates move higher. This can prove immensely beneficial during periods of market stress, giving the fund a robust use case for investors betting on volatility.
Davis noted that many of IVOL’s investors use the fund “as a complement to the Agg Index.” As an actively managed fund, IVOL can bolster a passive strategy with downside protection against inflation.
Considering Covered Call Strategies
For income-seeking investors, bond strategies are not the only funds that are showing results. A covered call strategy can provide equity exposure while fostering capital preservation.
Jeff Cullen, managing director at Cullen Capital Management, joined the VettaFi symposium to discuss the nuts and bolts of covered call strategies.
He noted that covered call strategies have been used by fund managers for decades. As a more accessible option, covered call ETFs can provide equity exposure, along with income-generating option writing.
“The nice part is, you get some equity participation, because you still own the underlying equities, and then you’re able to write this covered call option on some of the existing position that you have,” Cullen added.
Increasingly Popular Option
With the merits of covered call strategies in mind, he noted that these funds are becoming an increasingly popular option for income-seeking portfolio additions.
During periods of volatility, covered calls can provide results. In particular, Cullen added that covered call strategies can generate good income during periods of moderate economic growth or loss. This can be highly beneficial for the second half of the year, with the upcoming U.S. election creating potential uncertainty.
These strategies can serve well as a complementary piece to bond ETFs. Should interest rates go down, he noted that investors could pivot a portion of their fixed income assets to covered call ETFs to continue generating yield.
“Equities are actually a great hedge against long-term inflation,” Cullen noted. By using an equity-exposed income strategy, investors can benefit from potential upsides while still generating good yield.
The Cullen Enhanced Equity Income ETF (DIVP) can be a beneficial fund for investors seeking to use covered call strategies. DIVP is an ETF version of a Cullen Capital Management mutual fund with an established track record. The fund can provide both value and dividends, along with dividend growths.
Persistence of Fixed Income
Looking back at the Symposium as a whole, the VettaFi team discussed what moments and ideas stuck out to them in particular.
VettaFi Editor-In-Chief Lara Crigger highlighted her surprise at how many Symposium attendees reported that over half of their fixed income assets were in actively managed strategies. “Active management has really taken off this year, especially in the fixed income space,” she added.
‘Golden Age for Active Bond ETFs’
VettaFi Senior Industry Analyst Kirsten Chang expressed her agreement. She noted her belief that the market is “entering a golden age for active bond ETFs.” In using active bond ETFs, investors can capitalize on the yield curve and spectrum of credit quality options.
Todd Rosenbluth, head of research at VettaFi, noted that “strong results” have come from the financials sector. Additionally, preferred strategies can be an excellent means to gain exposure to financial institutions. He also noted that covered calls present an alternate means to gain income while maintaining good equity exposure.
“Fixed income has been one of the most dominant themes of 2024,” said Crigger. Looking down the line, she predicted fixed income would remain a hot topic through the remainder of the year and into 2025.
To watch the full symposium and receive CE credits, register for the replay here.
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