When stocks are down like they were last year, investors usually look towards treasuries for safety. But last year was unlike any other year. While the S&P 500 fell 18%, the Bloomberg U.S. Aggregate Bond index slumped 13%. However, a year like 2022 is unlikely to happen again any time soon. According to analysts, that leaves “room for those bonds to reclaim their role as a core risk-off allocation for asset owners this year.” For example, when SVB Financial Group recently announced hefty losses, the S&P 500 index fell 3.4% between March 8th and March 13th. But investors looking for a safe haven in long-dated Treasuries sent yields plunging, providing bondholders with a gain of more than 4%. Many analysts expect the conditions that led to close correlations between the stock and bond market “to prove ephemeral.” According to Jason Vaillancourt, global macro strategist with Putnam Investments, the biggest risk for those strong correlations is when "The Fed gets really fired up to fight inflation, as with the central bank's 'uh-oh' moment last year — when inflationary pressures it had deemed transitory proved anything but, forcing the central bank to shift aggressively to catch-up mode.” He added, “With the Fed frontloading its fight against inflation last year, the conditions required to maintain correlations at 1 this year are unlikely to persist.”
Finsum:With the Fed front-loading its fight against inflation last year, the conditions that led to a high correlation between the stock and bonds markets, aren’t likely to persist.
Vanguard recently expanded its tax-exempt bond ETF lineup with the launch of the Vanguard Short-Term Tax-Exempt Bond ETF (VTES), which is built to help investors earn consistent, tax-exempt income. The fund’s objective is to track the performance of the S&P 0-7 Year National AMT-Free Municipal Bond Index using a sampling technique to closely match key benchmark characteristics. The index measures the investment-grade segment of the U.S. municipal bond market with maturities between one month and 7 years. This is Vanguard’s first US-listed ETF launch in nearly two years. The ETF, which is managed by Vanguard Fixed Income Group, has been listed on NYSE Arca with an expense ratio of 0.07%. Sara Devereux, Global Head of Vanguard Fixed Income Group had this to say about the launch, “The Vanguard Short-Term Tax-Exempt Bond ETF is built to optimize tax efficiency for investors seeking to allocate to the shorter end of the municipal bond market. The new ETF complements our broad fixed income line-up and provides clients with another avenue to tap our municipal bond team’s talent and capabilities.”
Finsum:Vanguard expanded its tax-exempt bond ETF lineup with the launch of the Vanguard Short-Term Tax-Exempt Bond ETF (VTES), its first US-listed ETF launch in nearly two years.
Fidelity Investments recently announced it was adding to its active fixed-income strategies lineup with the launch of the Fidelity Municipal Core Plus Bond Fund (FMBAX). According to Fidelity, FMBAX is available commission-free and with no investment minimum to individual investors and financial advisors through Fidelity’s online brokerage platforms. The fund has a 0.37% net expense ratio and a 1.28% gross expense ratio. FMBAX is measured against the Bloomberg Municipal Bond Index and the Fidelity Municipal Core Plus Bond Composite Index, and aims to provide a high current yield exempt from federal income taxes, and may also consider capital growth. Co-managers Cormac Cullen, Michael Maka, and Elizah McLaughlin will analyze the credit quality of the issuer, security-specific features, current and potential future valuation, and trading opportunities to select investments. The fund launch comes at a time when the retail and institutional demand for higher-yielding municipal bond funds is growing. According to the fund giant, this new product seeks to offer a strong yield and total return profile, with potentially lower volatility than pure high-yield funds. Jamie Pagliocco, Fidelity’s fixed income head has this to say about the fund launch, “Fidelity’s growing suite of active fixed income investment products leverage Fidelity’s breadth and depth of resources and expertise as an active manager to identify investment opportunities across the credit spectrum.”
Finsum:Fidelity Investments launched an active municipal bond mutual fund amid increased retail and institutional demand for higher-yielding municipal bond funds.
While fixed-income ETFs are seeing strong inflows this year, academics from a trio of U.S. business schools suggest fixed-income ETFs can suck the liquidity out of corporate bonds during times of market stress. According to them, the potential problem stems from the creation and redemption baskets that ETF issuers trade with market makers, known as authorized participants (APs), to handle inflows or outflows from their ETFs. Unlike equity ETFs, bond funds’ creation and redemption baskets typically do not include every bond in the index they are tracking as this could include hundreds or even thousands of separate issues. In their paper, Steering a Ship in Illiquid Waters: Active Management of Passive Funds, the academics argue that in normal times a bond’s inclusion in an ETF basket makes the bond more liquid. This is due to a random mix of creations and redemptions increasing trading activity. But, during a crisis, when many investors are running for the exits, redemptions hugely outweigh creations. When that happens, if a bond is included in the basket, the APs “may then become reluctant to purchase more of the same bonds, reducing their liquidity,” according to the paper. However, other bond strategists disagree, including Dan Izzo, chief executive of GHCO, an ETF market maker. Izzo, who argues that the rise of ETFs had actually increased liquidity during periods of market stress, stated that “The causality ran in the opposite direction — it is because some bonds are illiquid that they increasingly feature in redemption baskets as sell-offs intensify, not vice versa.”
Finsum:While fixed-income ETFs continue to see strong inflows, a trio of academics argues that bond funds make the market less liquid during periods of stress.
As investors increasingly buy ESG funds, there has also been an increase in academic research on the impact of implementing ESG constraints on equity portfolios. However, there hasn't been as much attention paid to research on ESG fixed-income investing. Inna Zorina and Lux Corlett-Roy published their study “The Hunt for Alpha in ESG Fixed Income: Fund Evidence from Around the World,” in the Fall 2022 issue of The Journal of Impact and ESG Investing. In the study, they examined whether ESG fixed-income funds generate out- or under-performance after controlling for systematic fixed-income factors. They found that while ESG fixed-income funds with a higher level of risk generally produced higher returns, most ESG fixed-income funds did not produce statistically significant positive or negative gross alphas. In fact, only 7% of funds managed to deliver greater returns at a lower level of risk relative to the respective benchmark. The study revealed that across ESG fixed-income funds with a European, U.S., and global focus, performance was mainly driven by systematic fixed-income factor exposures such as term and default risk. The results led Zorina and Corlett-Roy to conclude: “ESG fixed-income mutual funds and ETFs have not consistently delivered statistically significant gross alpha controlling for key fixed-income factors. The majority of alphas are statistically insignificant and therefore indistinguishable from zero. This conclusion is similar across fixed-income funds with a European, US, and Global ESG investment focus.”
Finsum:A recent study that looked into whether fixed-income ESG funds provided outperformance revealed that ESG fixed-income mutual funds and ETFs have not consistently delivered statistically significant gross alpha.
Investors are piling into the investment-grade market at a record rate due to higher yields and concerns over riskier debt. A total of $19 billion has been poured into funds that buy investment-grade corporate debt since the start of 2023. That marks the most ever at this point in the year, according to data from fund flow tracker EPFR. The money pouring into the asset class underscores an eagerness among investors to buy historically high yields provided by safer corporate debt after years of investing in riskier debt in search of returns. According to Matt Mish, head of credit strategy at UBS, “People basically think that fixed income, in general, looks a lot more attractive than it has in prior years. The euphoria around investment grade is basically more broadly this euphoria around yields. At least relative to last year and really relative to most of the last decade, [high-grade corporate debt] is offering yields that are considerably higher.” For instance, average US investment grade yields have jumped to 5.45% from 3.1% a year ago. The soaring yields come as a result of the broad sell-off in fixed income over the past year as the Federal Reserve rapidly lifted interest rates to help tame sky-high inflation.
Finsum: Investors are piling into investment-grade bond funds due to historically high yields on safer debt after years of investing in riskier debt in search of returns.