The next meeting of the Federal Reserve will be held mid-week next week, with all indicators pointing to another 0.50% interest rate increase. In an environment of rising rates where equities and bonds have both proven fairly problematic in their performance, focus within bonds has turned to whether the U.S. Treasury yield has peaked or still has further to go.
Kevin Flanagan, head of fixed income strategy at WisdomTree, made a case for bond investors who are trying to optimize their portfolios by “timing the market” to instead rely on a well-established approach through the use of a barbell strategy.
A barbell strategy is an investment style that mimics the shape of a barbell: Instead of trying to find a middle ground of risk compared to returns, investors allocate to both ends of both no/low-risk and high-risk securities. Within bonds this typically means investing in long-term bonds (over 10 years) on one end and short-term bonds (three years or less) on the other end.
As of writing, the 10-year Treasury yield is currently at 3.023%, a 150 basis point increase since the beginning of 2022. The 10-year yield was as high as 3.20% recently, but as concerns have shifted away from rampant inflation and more towards recession concerns and over-tightening by the Fed, the yield fell briefly but is on the rise once more.
“The current debate among bond investors is trying to decide if it is now time to go longer duration because rates, such as the UST 10-Year yield, may have already risen as high as they are going to in this cycle,” wrote Flanagan. “But I ask, what if the May rally was just a short-term consolidation?”
WisdomTree is currently not factoring in a recession as its base case scenario but is instead anticipating economic slowdown to the tune of 2% real GDP over the next 12 months. In this kind of environment, WisdomTree believes that the yield on the 10-year will likely make a “run” at 3.25%, the peak from 2018, with the potential to go even higher.
It’s a difficult environment in which to try to determine optimal duration. By relying on a barbell strategy, advisors and investors can remove the need to try to forecast rates by being invested in short-term bonds on one side and intermediate- to long-term bonds on the other, with the ability to allocate heavily towards one or the other depending on their investment needs.
Investing in the WisdomTree Barbell
The WisdomTree Yield Enhanced U.S. Aggregate Bond Fund (AGGY) offers long-term bond exposure and seeks to track the Bloomberg US Aggregate Enhanced Yield Index, an index that uses a rules-based approach to reweight subgroups of the Agg in an attempt to earn higher yield. The index divides investment-grade securities into different risk dimensions such as interest rate risk, credit risk, and sector exposures and pulls from the treasury and agency sectors, credit markets, and securitized securities. The duration range of the fund is expected to be within a year of the Agg and the fund has an expense ratio of 0.12%.
The WisdomTree Floating Rate Treasury Fund (USFR) offers short-term bond exposure and seeks to track the Bloomberg U.S. Treasury Floating Rate Bond Index. The index measures the performance of floating-rate notes of the U.S. Treasury and contains floating-rate notes with two-year maturities and a minimum outstanding amount of $1 billion. The index uses a rules-based strategy and is weighted by market cap. The index excludes fixed-rate securities, Treasury inflation-protected securities, convertible bonds, and bonds with survivor put options, and the fund carries an expense ratio of 0.15%.
“This barbell offers a core strategic solution designed to help fixed income investors navigate the uncharted waters ahead without making a high-conviction bet on where Treasury yields may ultimately be headed,” Flanagan wrote.
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