By Bradley Krom
From 2009 through the middle of 2013, fixed income investing turned out to be fairly straightforward. The more credit risk and interest rate risk investors assumed in their portfolio, the higher their returns. In the second half of last year, interest rates rose and emerging markets fell out of favor. So far in 2014, falling interest rates have boosted longer-maturity bonds. Emerging markets are also making up for losses experienced last year. But a key takeaway, in our view, is that over the past five years, having the flexibility to rotate among the various flavors of fixed income around the world yielded the best results. As interest rates continue to grind lower and credit spreads continue to tighten, selectivity will continue to become even more critical, in our view. The low-hanging fruit for credit investors might be gone, but selective opportunities still exist. Perhaps more importantly, potential to avoid the problem spots in the market could have a significant impact on performance in the coming years.
Performance Rotation across Corporate Bond Sectors
For definitions of terms and indexes in the chart, please visit our Glossary.
As shown in the graphic above, the common theme since the global financial crisis has been to increase credit risk in portfolios and also to be willing to take a global approach to fixed income. In fact, U.S high yield debt has been a top three performer every year since 2008. Outside the U.S., emerging markets have also performed well, excepting 2013. Perhaps one of the most interesting elements, though, is the continued slow performance in the international investment-grade market. While it arguably represents one of the most resilient asset classes-having delivered positive performance in every year since 2008 (where it declined by only 4.7%)-it has remained one of the slowest-performing cuts of fixed income due to European economic difficulties in recent years. However, with the economic picture in Europe slowly improving, certain issuers in this subset of the market may present unique opportunities for value.
In terms of interest rate risk, the market's view has shifted in recent months. In the second half of 2013, virtually no analyst thought rates would fall in 2014. Now, after U.S. rates have fallen back to levels not seen since last June amid investors' grappling with Fed tapering, the common refrain has changed to rates remaining "lower for longer." While the consensus sees U.S. rates still higher by the end of the year, allowing a portfolio management team whose sole focus is fixed income could be an effective way to manage risk.
In our view, enlisting the expertise of a portfolio manager focused on balancing these risks could have a great deal of value in the current market environment. While these decisions will be only as effective as the analysis supporting them, we believe that allowing a dedicated team to help navigate the current uncertainty in the market may help many investors get better risk-adjusted returns in the long run.
Source: Bloomberg, as of 3/31/14
Important Risks Related to this Article
There are risks associated with investing, including possible loss of principal. Foreign investing involves special risks, such as risk of loss from currency fluctuation or political or economic uncertainty. Investments in emerging, offshore or frontier markets are generally less liquid and less efficient than investments in developed markets and are subject to additional risks, such as risks of adverse governmental regulation and intervention or political developments. Derivative investments can be volatile and these investments may be less liquid than other securities, and more sensitive to the effects of varied economic conditions.
Fixed income investments are subject to interest rate risk; their value will normally decline as interest rates rise. In addition when interest rates fall income may decline. Fixed income investments are also subject to credit risk, the risk that the issuer of a bond will fail to pay interest and principal in a timely manner, or that negative perceptions of the issuer's ability to make such payments will cause the price of that bond to decline. Unlike typical exchange-traded funds, there is no index that the Fund attempts to track or replicate. Thus, the ability of the Fund to achieve its objective will depend on the effectiveness of the portfolio manager. Please read the Fund's prospectus for specific details regarding the Fund's risk profile.
Bradley Krom, Research Analyst
Bradley Krom joined WisdomTree as a member of the Fixed Income and Currency team in December 2010. He is involved in creating and communicating WisdomTree's thoughts on currency and fixed income markets, as well as analyzing existing and new fund strategies. Prior to joining WisdomTree, Bradley served as a senior trader on a proprietary trading desk at TransMarket Group.