- Today, investors need to consider an approach that allows them to remain invested in key sectors that can generate income while also navigating the uncertainty of interest rate moves and market volatility.
- Investors could benefit from owning lower-duration, diversified fixed-income solutions that invest in higher income-producing sectors, such as high-quality high yield, emerging market debt and broad use of structured assets.
- Together with investment-grade corporate bonds, these sectors typically experience low correlation and can provide attractive income and capital appreciation, while keeping overall duration reasonably low.
By Edward Kerschner, Chief Portfolio Strategist; Ronald Stahl, CFA, Senior Portfolio Manager, Head of Short Duration and Stable Value; Neeraj Agarwal, Investment Research Analyst
Fixed-income investors limit their opportunity set when they focus on benchmark-tracking or benchmark-hugging strategies. But many investors do it anyway.
Investors faced with macroeconomic and capital market uncertainties have been moving into short-duration fixed-income solutions. Dominated by shorter all-corporate or government/corporate debt, these solutions offer little diversification by sector, credit quality or country allocation - where wider spreads and higher yields are often found.
Traditional benchmarks like the Bloomberg U.S. Aggregate Bond Index and the Bloomberg Short-Term U.S. Aggregate Bond Index have delivered annualized returns of 4.9% and 3.8% since 2000, respectively. But these benchmarks have changed their composition pretty significantly since the Great Recession. The Agg’s weight in Treasury securities ballooned, corporate and securitized exposure in the index shrank, and the benchmark extended duration and lowered yield as a result. While duration for the Short-Term Agg is relatively constant, yields are currently very low. Meanwhile, the duration of the Agg is at its peak since 2000. Longer duration means greater risk of price declines if rates rise even modestly.
The constituents in the Morningstar Short-Term Bond category overwhelmingly use versions of shorter all-corporate or government/corporate indices - offering little diversification by sector, credit quality or country allocation - where wider spreads and higher yields are often found. Not surprisingly, the Short-Term Agg has a 99% correlation to the Bloomberg 1-5 Year Government/Credit Index, one of most frequently used indices in the category.1
Better return due to sourcing better income opportunities
Investors could benefit from owning lower-duration, diversified fixed-income solutions that invest in higher income-producing sectors, such as high-quality high yield, emerging market debt and broad use of structured assets. Together with investment-grade corporate bonds, these sectors typically experience low correlation and can provide attractive income and capital appreciation, while keeping overall duration reasonably low.
The short end of the yield curve is often referred to as the “sweet spot,” where investors can typically find the most attractive risk-reward profiles. Today, investors need to consider an approach that allows them to remain invested in key sectors that can generate income while also navigating the uncertainty of interest rate moves and market volatility.
¹ Source: Bloomberg, 01/01/00-06/30/21
Past performance is not a guarantee of future results.
The Bloomberg U.S. Aggregate Bond Index (U.S. Aggregate) is a broad-based benchmark that measures the investment-grade, U.S. dollar-denominated, fixed-rate taxable bond market. The index includes treasuries, government-related and corporate securities, MBS (agency fixed-rate and hybrid ARM pass-throughs), ABS and CMBS (agency and non-agency). The Bloomberg Short-Term U.S. Aggregate Bond Index is a subset of the Bloomberg Barclays U.S. Aggregate Index and measures the investment-grade, U.S. dollar-denominated, fixed-rate taxable bond market. The index includes treasuries, government-related and corporate securities with up to, but not including, five years to maturity. The Bloomberg U.S. 1–5 Year Government/Credit Float Adjusted Index includes U.S. Treasury and agency obligations, as well as investment-grade (rated Baa3 or above by Moody’s) corporate and international dollar-denominated bonds, all having maturities of one to five years. It is not possible to invest directly in an index.
Duration is a time measure of a bond’s interest-rate sensitivity, based on the weighted average of the time periods over which a bond’s cash flows accrue to the bondholder. Yield to worst is the lowest potential yield that can be received on a bond without the issuer actually defaulting.
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