Over the past couple of months, Russ Koesterich has been outlining his outlook for markets and economies in the coming year. In short, he believes the most likely scenario is that the world -- in particular, the U.S. -- will continue to see slow but stable growth in 2013, with developed markets increasingly being influenced by policy decisions.
Turning to bond markets specifically, perhaps the biggest factor shaping 2013 is the ongoing low interest rate environment, which doesn't look to be changing significantly anytime soon. The Fed has made its intentions clear, targeting an unemployment level with a limit on inflation before being willing to raise rates. Meanwhile there continues to be heightened demand for U.S. Treasuries from non-price sensitive central banks and investors seeking perceived "safe haven" investments. Until the Fed acts and Treasury demand wanes, we're likely to experience depressed rates for the foreseeable future.
So what are the implications for bond investors? Here are a few strategies to consider:
- Focus on municipals and credit. The hunt for yield will continue to be a challenge in 2013, so we'd expect to see a sustained interest in riskier fixed-income sectors such as high- yield and investment-grade credit bonds. Also, municipal bonds remain competitive on a tax-adjusted basis for U.S. investors. Potential iShares solutions: iShares High Yield Corporate Bond ETF (NYSEARCA:HYG), iShares Investment Grade Corporate Bond ETF (NYSEARCA:LQD), and iShares National AMT-Free Muni Bond ETF (NYSEARCA:MUB).
Look outside the U.S. Just as equity investors are reassessing home country bias this year, so are bond investors finding more opportunities outside the U.S. and, in some cases, outside of developed markets. In 2012, demand for emerging market bond exchange-traded products (ETPs) doubled to $20 billion. As investors continue to diversify their bond holdings and search for yield, we expect this will remain a popular category. Potential iShares solution: iShares Emerging Markets USD Bond ETF (NYSEARCA:EMB).
- Rethink the role of Treasuries. While we're not likely to see significantly higher rates in 2013, even a modest increase in yields would have a significantly negative impact on Treasury prices. But does this mean that investors should avoid them altogether? Not so fast. As bond investors rotate into the sometimes much-riskier sectors mentioned above, it's important to remember that even a small amount of Treasuries can anchor a portfolio's risk. Potential iShares solution: iShares Treasury Bond ETF (NYSEARCA:GOVT).
No matter what the outlook is, you should always consider what role fixed income is playing in your portfolio when implementing a bond strategy. Is the objective to provide income? Lower overall portfolio risk? Add diversification? The answers to these questions can be the key to selecting the right bond investment for you in 2013 and beyond.
Sources: BlackRock, Bloomberg.
Disclaimer: Bonds and bond funds will decrease in value as interest rates rise and are subject to credit risk, which refers to the possibility that the debt issuers may not be able to make principal and interest payments or may have their debt downgraded by ratings agencies. An investment in the Fund(s) is not insured or guaranteed by the Federal Deposit Insurance Corporation or any other government agency. High yield securities may be more volatile, be subject to greater levels of credit or default risk, and may be less liquid and more difficult to sell at an advantageous time or price to value than higher-rated securities of similar maturity. A portion of MUB’s income may be subject to federal or state income taxes or the alternative minimum tax. Capital gains, if any, are subject to capital gains tax. In addition to the normal risks associated with investing, international investments may involve risk of capital loss from unfavorable fluctuation in currency values, from differences in generally accepted accounting principles or from economic or political instability in other nations. Emerging markets involve heightened risks related to the same factors as well as increased volatility and lower trading volume.