Based on the latest treasury yield movements, investors are bracing for a recession. Yields on the benchmark U.S. 10-year Treasury note have fallen by around 83 basis points from their October high of 4.338% as investors sent $4.89 billion into U.S. bond funds last week. That marks the third straight week of net inflows. The bond rally comes after Treasuries had the worst year ever, driven by the Fed's tightening policy. The key driver for the current rally has been concerns over the Fed's rate increases sending the U.S. economy into a recession. Treasuries are typically seen as a safe haven during economic uncertainty. Investors expect the Fed to raise rates by another 25 basis points at the end of its monetary policy meeting today, while Wall Street is also looking for signs that the Fed will pull back on its hawkish stance amid falling inflation. Rob Daly, director of fixed income at Glenmede Investment Management told Reuters that "Things are coming off the boil here. There is a de-risking that's happening, and we're seeing flows out of equities into higher quality parts of the market such as fixed income." Although stocks have been rallying since late last year, investors are playing it safe, expecting the rally to end if a recession hits.
Finsum:While stocks have been in a mini rally since the end of last year, investors are playing it safe flooding U.S. bonds funds in the expectation of a recession.
After struggling under deficits for two decades, pension funds are now flooded with cash due to soaring interest rates. The surplus at corporate defined-benefit plans means managers can now reallocate to bonds, which are less volatile than stocks. This is called “derisking” in the industry. Mike Schumacher, head of macro strategy at Wells Fargo, said the following in an interview, “The pensions are in good shape. They can now essentially immunize — take out the equities, move into bonds, and try to have assets match liabilities.” That explains some of the rallying of the bond market over the last three or four weeks.” Last year’s stock and bond market losses actually helped some benefit plans, whose future costs are a function of interest rates. When rates rise, their liabilities shrink and their funded status improves. For instance, the largest 100 US corporate pension plans now have an average funding ratio of about 110%. According to the Milliman 100 Pension Funding index, that’s the highest level in more than two decades and great news for fund managers who had to deal with low-interest rates and were forced to chase returns in the equity market. Now managers can unwind that imbalance with most banks expecting them to use the extra cash on buying bonds and selling stocks to buy more bonds.
Finsum: Due to stock and bond losses and rising rates, pension fund managers now have a surplus of funds that they plan on allocating to bonds.
Fidelity expanded its active fixed-income ETF lineup with the launch of the Fidelity Tactical Bond ETF (FTBD). FTBD, which now trades on the NYSE Arca, has an expense ratio of 0.55%. The fund is co-managed by Jeffrey Moore and Michael Plage and is measured against the Bloomberg U.S. Aggregate Bond Index. The fund's portfolio can be allocated across the full spectrum of the debt market, including investment-grade, high-yield, and emerging markets debt securities across different maturities. Managers will consider the credit quality of the issuer, security-specific features, current and potential future valuation, and trading opportunities to select investments. The launch brings Fidelity’s lineup to 12 active fixed-income ETFs with about $3.9 billion in assets under management. Jamie Pagliocco, Fidelity’s Head of Fixed Income told VettaFi that “Fidelity is committed to offering investors choice and providing a diverse lineup of investment solutions. Fidelity’s fixed income lineup combines our extensive investment capabilities and expertise as an active manager to provide investors with a range of solutions across the fixed income risk spectrum and vehicle type, and Fidelity Tactical Bond ETF provides investors with another competitive offering to further expand client vehicle choice.”
Finsum:Fidelity expands its lineup of actively managed fixed-income ETFs with the launch of the Fidelity Tactical Bond ETF which can invest across the full spectrum of the debt market.
Putnam recently announced the launch of five new transparent, actively managed exchange-traded funds, including three fixed-income ETFs that build upon the capabilities and experience of the firm’s Fixed Income team. The bond ETFs include the Putnam ESG Core Bond ETF (PCRB), the Putnam ESG High Yield ETF (PHYD), and the Putnam ESG Ultra Short ETF (PULT). As part of the announcement, Carlo Forcione, Head of Product and Strategy at Putnam stated, “We are enthused about extending our ETF product shelf into the actively managed fixed income and non-U.S. equity spaces.” PCRB invests in bonds of governments and private companies located in the United States that are investment grade in quality with intermediate- to long-term maturities with a focus on issuers that Putnam believes meet relevant ESG criteria. PHYD invests in bonds that are below investment grade in quality which are obligations of U.S. issuers and have intermediate- to long-term maturities. The fund will also focus on issuers that Putnam believes meet relevant ESG criteria on a sector-specific basis. PULT invests in a diversified portfolio of fixed-income securities composed of short-duration, investment-grade money market, and other fixed-income securities, with a focus on issuers that the firm believes meet relevant ESG criteria on a sector-specific basis.
Finsum:Putnam recently launched three actively managed bond ETFs, including the Putnam ESG Core Bond ETF, the Putnam ESG High Yield ETF, and the Putnam ESG Ultra Short ETF.
Last week, over $10.2 billion went into U.S.-listed ETFs, with the majority going into fixed-income funds. Bond ETFs pulled in $4.5 billion according to ETF.com data. This followed the previous week’s $7.8 billion in inflows that went into bond funds. In the first week in January, fixed-income products pulled in $9.4 billion, a jump from $1.5 billion in the last week of December. Investors are flocking to fixed-income exchange-traded funds as recession warnings ring louder. Investors are jumping from stocks to bonds as they are often seen as a safer investment during economic downturns. Earlier in the month, Bloomberg News reported that Wall Street firms are sounding the alarm for a recession in 2023. BlackRock’s Investment Institute stated that “a recession is foretold,” while Barclays is predicting “one of the weakest years for the world economy in 40 years.” This also comes after multiple Fed officials have predicted interest rates remain elevated for the foreseeable future. Federal Reserve Bank of San Francisco President Mary Daly said in a streamed interview with the Wall Street Journal a couple of weeks ago that “I think something above 5[.0%] is absolutely, in my judgment, going to be likely.” Her comments come a week after Minneapolis Fed President Neel Kashkari stated that the “central bank’s so-called terminal rate could reach as high as 5.4% before easing,” in a post on Medium.
Finsum:As Wall Street firms sound the alarm on a potential recession, investors are flocking to fixed-income ETFs, which are seen as safer investments during economic downturns.
While bonds are generally known for their stability, 2022 marked a deviance from the norm. The question for advisors is, how should they approach 2023? Mariam Kamshad, head of portfolio strategy for Goldman Sachs personal financial management, and Guido Petrelli, CEO, and founder of Merlin Investor spoke to SmartAsset to provide some guidance. First advisors should expect a return to the norm. Kamshad said 2022 was an unusually bad environment for bonds with the Federal Reserve raising rates to a 15-year high. She believes that's unlikely to repeat and expects both yields and capital gains returns to stabilize. Second, advisors should pay attention to inflation and government bonds. Kamshad believes that inflation is still the biggest issue in the economy and expects it to continue slowing in 2023, which would likely slow interest rates. Her team considers duration risk a better bet than credit risk. Kamshad's team also recommends investors consider government bonds. The team expects intermediate Treasurys to outperform cash. They also expect municipal bonds to pick back up. Petrelli recommends following the unemployment rate and the quit rate as they are “good metrics for the strength of the economy overall and a window into where bonds are headed.” He believes a potential recession is one of the biggest questions facing the bond market. In a recession, Petrelli expects investors to favor short-term bonds.
Finsum:According to two portfolio analysts, advisors should expect a return to the norm for bonds, but they should also keep an eye on inflation, government bonds, and the jobs report.
According to Vanguard, investors that allocated part of their portfolios to low-yielding municipal bonds at the beginning of last year should now be looking forward to the prospect of higher income, thanks to a rapid rise in rates. In a fixed-income report for the first quarter, the fund firm wrote, “Following a year with $119 billion of outflows from municipal funds and ETFs, we expect the tide to turn. For high-income taxable investors, we are expecting a municipal bond renaissance.” According to the report, muni bonds only offered yields of around 1% at the start of 2022, compared to yields that now exceed 3% before adjusting for tax benefits. Tax-equivalent yields are at 6% or even “meaningfully higher for residents in high-tax states who invest in corresponding state funds.” Vanguard said that this makes munis a “great value compared with other fixed income sectors and potentially even equities—especially with the odds of a recession increasing.” According to the Vanguard report, muni bonds also remain strong from a credit perspective, with attractive spreads over comparable U.S. Treasurys and corporate debt. In fact, municipal balance sheets are stronger now than they’ve been in two decades, leaving states well-prepared to navigate an economic slowdown.
Finsum:According to Vanguard, higher yields and solid balance sheets make muni bonds a highly attractive option for investors this year.
Last year, portfolios that were allocated to 60% stocks and 40% bonds were hammered, as both the stock and bond markets sustained heavy losses. The portfolio has generally yielded steady gains with lower volatility since the two asset classes typically move in opposite directions. However, the strategy backfired last year after the Fed’s tightening policy sent stocks tumbling from record highs and drove Treasuries to the worst losses since the early ‘70s. This made advisors and investors question the viability of the 60/40 model. But the bond market’s selloff last year pushed yields so high that analysts at BlackRock, AQR Capital Management, and DoubleLine expect fixed-income securities to breathe new life into 60/40 portfolios. This year, both stocks and bonds have gained, propelling the 60/40 portfolio to the best start to a year since 1987. Their view is supported by the expectations that the Fed is nearing the end of its tightening policy as inflation comes down. If this view turns out to be correct, it reduces the risk of bond prices falling again and allows them to once again serve as a hedge against a potential drop in equities stemming from a recession. In a note to clients, Doug Longo, head of fixed-income strategists at Dimensional Fund Advisors, wrote “Expected returns in fixed income are the highest we’ve seen in years.”
Finsum:Based on the view that the Fed is nearing the end of its tightening cycle, analysts expect fixed-income securities to once again serve as a hedge against stocks in the 60/40 portfolio.
Blackrock expanded its fixed-income ETF lineup with the launch of the BlackRock AAA CLO ETF (CLOA). The fund, which was launched on January 10th, seeks to provide capital preservation and current income by investing principally in a portfolio composed of U.S. dollar-denominated AAA-rated collateralized loan obligations (CLOs). According to Investopedia, a CLO is a bundle of loans that are ranked below investment grade. While the underlying loans are rated below investment grade, most CLO tranches are typically rated investment grade due to credit enhancements and diversification. CLOs have historically only been available to institutional investors, but Janus Henderson launched the first CLO fund in an ETF wrapper in October 2020. That fund, the Janus Henderson AAA CLO ETF (JAAA) was clearly able to find an audience since the fund currently has close to $2 billion in assets under management. This bodes well for CLOA, which has an expense ratio of 0.20%, six basis points cheaper than JAAA. Investors have been attracted to CLOs due to low volatility, low downgrade risk, and low correlations with traditional fixed-income assets. CLOA currently has a weighted average coupon of 5.40 and a weighted average maturity of 4.24 years.
Finsum: Blackrock launched an AAA CLO ETF to take advantage of investor CLO interest due to low volatility, low downgrade risk, and low correlations with traditional fixed income.
Principal Asset Management recently announced that it is enhancing its fintech-enabled model portfolios by incorporating individual bonds as an option for the portfolios. The company collaborated with YieldX and Smartleaf Asset Management to offer the only full portfolio direct indexing solution, enabling advisors to expand the capabilities of direct indexing beyond equities to individual bonds. Principal launched fintech-enabled model portfolios last year in collaboration with Smartleaf to make it easy to construct and manage custom portfolios. As part of the announcement, Jill Brown, Principal's managing director of U.S. Wealth Platform, stated, “We are the first asset manager to work with YieldX to incorporate individual bonds into model portfolios, making the combinations of mutual funds, ETFs, individual equities, and now individual bonds available through our 37 model portfolios even more powerful.” Adam Green, CEO of YieldX added “Through the addition of capabilities from YieldX, advisors will now have the option to include individual fixed-income securities.”
Finsum:Principal collaborated with YieldX and Smartleaf to offer individual bonds as part of its direct indexing model portfolios.
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Corporate executives are warning that the volatile market, combined with the Fed’s rate hikes and the war in Ukraine will negatively impact fourth-quarter earnings, while analysts have downgraded earnings expectations in every sector. However, there may be a bright spot during earnings season, ETF issuers. According to ETF.com data, ETF flows came in at $203 billion in the fourth quarter, nearly double the third quarter's flows of $105 billion. The increase in flows should help fourth-quarter earnings for ETF issuers. It would also be a reversal from the previous quarter when State Street reported $14 billion in net outflows and Schwab’s ETF revenue declined sharply. ETF inflows at BlackRock’s iShares also fell by more than half compared with the third quarter of last year. The surge in inflows during the fourth quarter can be attributed to the rising demand for fixed-income ETFs. Investors are flocking to bond ETFs as they are considered safe havens during downturns. BlackRock President Rob Kapito said on the company’s third-quarter earnings call, “We're going to see dramatic and large inflows into fixed income over the next year as interest rates rise.” ETF.com data shows that fixed-income funds saw inflows of $61 billion in the fourth quarter, up nearly 13% from the $54 billion in the prior-year quarter.
Finsum:While analysts are predicting a dismal fourth-quarter earnings season, ETF issuers may be a bright spot as fixed-income funds saw inflows of $61 billion during the quarter.
Last month, we wrote about a survey that revealed advisors are seeing the importance of active ETFs since owning passive index-only ETFs left them too exposed to market conditions. Another survey was performed this month showing similar results. VettaFi held a webcast called Active Strategies for Rising Rate Headwinds that featured Franco Ditri and Chris Murphy of T. Rowe Price and Todd Rosenbluth of VettaFi talking about the Fed’s monetary policy outlook and how financial advisors can incorporate active strategies into a bond portfolio. After the webcast, a poll was taken revealing that more advisors are seeing the need to add active management to their portfolios, given the likelihood that the Fed will continue to raise rates. The majority of respondents expect to increase their exposure to active ETF strategies, with 50% being “very likely” and 39% saying they are “somewhat likely.” Of those, 39% of respondents said they would most likely consider high-yield/bank loan funds for exposure, with 27% saying they would consider active short-term bond funds. In addition, 20% are contemplating core-plus and 14% are looking toward core bond funds. If the Fed continues its tightening policy, actively managed fixed-income strategies could help reduce risk.
Finsum:A post-webcast poll revealed that more advisors are seeing the importance of active fixed income with the Fed continuing to pursue a tight monetary policy.
While rising interest rates last year battered both stocks and bonds, the rise in rates brought higher yields to the fixed-income market. According to Dow Jones Market Data, the yield on the 10-year Treasury note rose 2.330 percentage points in 2022 to 3.826%, its largest annual gain on record. The two-year Treasury yields surged 3.669 percentage points to 4.399%, while the 30-year yield jumped 2.046 percentage points to end the year at 3.934%. These marked the largest annual increases ever for those notes. The jump in yields drove investors into fixed-income ETFs last year, with BlackRock's iShares dominating inflows. In a phone interview with Morningstar, Salim Ramji, BlackRock's global head of iShares and index investments, stated "We had record flows even in one of the worst fixed-income markets. We were twice the next competitor." Based on data from Morningstar Direct, iShares attracted around $100 billion in 2022, the most among U.S.-listed ETFs that invest in fixed income. Vanguard saw the second biggest fixed-income ETF inflows with around $49 billion, followed by State Street with about $21 billion. The most popular fixed-income ETF based on inflows last year was the iShares 20+ Year Treasury Bond ETF (TLT), which gathered around $15 billion.
Finsum: In an ugly year for fixed-income markets, bond ETFs continued to see strong inflows due to higher yields with Blackrock’s iShares leading the pack.
After a tough year for fixed income, many bond strategists are expecting 2023 to be a great year for bonds. But where should advisors and investors look to invest? In an interview with Yahoo Finance Live, PIMCO Managing Director and Portfolio Manager Sonali Pier offered her perspective on where the sweet spot will be for bonds this year. She believes that despite potential volatility, “there’s a lot of room now for income-producing assets.” She stated, that “a sweet spot may be those Triple Bs within investment grade, for example, where dollar prices have come down a lot as a result of the interest rates rising as well as credit spreads having widened.” In the interview, she also talked about what areas of the corporate bond market to avoid. Her firm is most concerned with areas where there are “low multiples on businesses, low margins, high cyclicality, where it's very difficult to weather a storm like a recession when you have those types of things against you as well as still inflation as an impact.” She mentioned industries such as retail, autos, and wire lines to avoid that are seeing declines due to a “shift in investor demand as well as disruption from the supply chain.”
Finsum:PIMCO portfolio manager Sonali Pier believes that a sweet spot for bonds this year may be triple Bs within investment grade while avoiding industries such as retail, autos, and wire lines.