Displaying items by tag: fixed income

Currently, fixed income investors can lock in yields that are in-line with the average, historical return in equity markets. According to David Leduc, the CEO, Insight Investment North America, this is a major reason we are in a new ‘golden age’ for bonds. 

Another reason to be bullish on the asset class is that most funds are deployed via passive strategies. This has increased liquidity and decreased transaction costs, while also leading to more inefficiencies which astute active managers can capitalize upon. 

Leduc believes that fixed income benchmarks are inherently flawed given that indexes are weighted based on debt issuance. The end result is that passive fixed income investors are overexposed to the most indebted companies.

In contrast, active managers can achieve alpha through careful selection in terms of value, credit quality, and duration. While passive funds invest in a relatively small slice of the fixed income universe, active managers have much more latitude in terms of securities to better optimize portfolios in terms of risk and return. One constraint for active managers is that some strategies are successful but can’t necessarily be scaled. Many err by simply sticking to duration positioning which increases near-term volatility.

Finsum: It’s a golden age for fixed income with bonds offering equity-like returns. Here’s why investors should favor active strategies especially as the risk of a recession grows.  

Aeon conducted a survey of pension funds, insurance asset managers, family offices, and wealth managers. Among the findings was that a majority plan to increase their allocation to active fixed income funds over the next 2 years. Currently, about 17% of respondents have less than 10% of their portfolios in active fixed income strategies, while 20% have between 50 and 75% of their portfolio in active fixed income. Overall, respondents are willing to trade liquidity for greater returns and diversification. 

The survey also indicates that 13% of respondents plan to ‘dramatically’ increase exposure, while 81% plan to do so ‘slightly’. In terms of return expectations, 55% are looking for between 3 and 5%, while 36% are looking for between 5 and 7%. 

In terms of alternatives, there was nearly unanimous consensus that the asset class would continue to grow as 74% see a slight increase over the next 2 years, while 16% see a dramatic increase. 

Another area of agreement is that these allocators are looking for fund managers with a ‘broad mandate’ to invest in several credit markets. The respondents also shared the view that they would be increasing allocation to private credit with 24% looking to ‘dramatically’ increase, and 67% seeing a slight increase. 

Finsum: Aeon conducted a survey of institutional investors. Among the findings was a consensus agreement that allocations to active fixed income strategies would materially increase over the next 2 years. 

Taking a look back at the previous year can reveal some interesting lessons for fixed income investors. Overall, fixed income finished the year in the green as inflation finally started to ease. This led the Federal Reserve to pause interest rate hikes, and expectations are for it to start cutting rates sometime next year, resulting in the Bloomberg Aggregate US Bond ETF finishing up 5.5% last year. 

However, there was considerable variance in performance across the curve and within different sectors. The best-performing segment was CCC-rated corporate debt which finished the year up 20.1%. 

While the combination of low defaults and falling interest rates is a bullish combination for high-yield debt, this variance in performance also highlights the importance of selection. To this end, BondBloxx offers fixed income ETFs that target specific sectors and credit ratings. 

The BondBloxx CCC-Rated USD High Yield Corporate Bond ETF offers exposure to CCC-rated corporate debt. The firm also offers high-yield fixed income ETFs that provide exposure to specific sectors such as consumer cyclicals, or telecom, media & technology. In total, BondBloxx has 20 different ETFs with a cumulative total of $2.5 billion in assets. It’s known for its innovation in providing more targeted investment vehicles. 

Finsum: 2023 saw fixed income performance that was in-line with historical averages. However, there was considerable dispersion within the asset class. For instance, CCC-rated corporate debt finished the year up more than 20%. 

Entering 2023, the consensus was that fixed income would outperform. This turned out to be incorrect as the economy and inflation proved to be more resilient than expected. For the year, the Bloomberg US Aggregate Index returned 5.5% which is in-line with the average return although the bulk of gains came in the final months of the year.  

As the calendar turns, the consensus is once again that the Fed is going to be embarking on rate cuts. Currently, the market expects 6 cuts before year-end which means there is room for downside in the event that the Fed doesn’t cut as aggressively. According to Bernstein, this may be premature as the firm sees many reasons for upward pressure on yields including inflation re-igniting, heavy amounts of Treasury debt issuance, and an acceleration of economic growth. 

Bernstein recommends that investors eschew more expensive parts of fixed income like high-grade corporate debt. Many are unprepared for a scenario where spreads tighten or rates fall less than expected. Instead, it favors segments that would benefit from stronger growth like preferred securities and AAA collateralized loan obligations (CLOs). The firm also likes TIPS and the 2Y Treasury as these offer attractive yields and inflation protection. 

Finsum: While most of Wall Street is bullish on fixed income in 2024, Bernstein is more cautious due to its expectations that rates will fall less than expected, while valuations are not as attractive. 

Stocks and bonds were both down following comments by Federal Reserve Governor Christopher Waller that rate cuts will be implemented slowly. Both are now in the red on a YTD basis. According to Waller, “When the time is right to begin lowering rates, I believe it can and should be lowered methodically and carefully.” As opposed to previous cycles, when cuts were implemented aggressively and quickly, Waller sees a slower, more gradual pace this time around. 

His comments had a chilling effect, especially as financial markets had been in a buoyant mood, looking ahead to rate cuts later this year and the possibility of a ‘soft landing’. While Waller injected a dose of hawkishness, recent economic data has also been on the weak side, adding to recession fears. Needless to say, such developments reduce the odds of a ‘soft landing’ scenario.

Currently, Fed futures markets indicate a 60% chance of a cut at the March FOMC meeting. Going into that meeting, inflation and labor market data will be major factors in this decision and market-moving events. Q4 earnings season is also starting, and it will be worth watching whether the improvement in Q3 will continue. The current consensus is for S&P 500 Q4 earnings to increase by 1.6% compared to last year.  

Finsum: Stocks and bonds weakened following hawkish comments from Fed Governor Waller. Waller sees a slower pace of rate cuts during this cycle than previous ones.