Recent markets have been a rollercoaster for fixed income investors. After a gloomy 2022, bond markets were on the road to recovery in the first half of 2023, only to see volatility surge back this past summer.
What a difference six months make. In my last letter, we were coming off a dismal 2022 where central banks roiled global markets with aggressive rate hikes in an attempt to quell stubbornly high inflation. And while 2023 has not come without its own headlines—March’s banking crisis and a close call with a US Treasury default in May come to mind—in general, bond investors were able to breathe easier this year.
Overall, ultra aggressive bank policy has worked—we have seen a decline in global inflation, though the readings are still higher than central banks’ target ranges. In the US, we have neared (or, depending whom you ask, reached) peak policy rates while the EU and UK central banks are lagging, with more hikes expected given persistently strong jobs and wage growth data. Bond markets were on the path to recovery after 2022’s carnage, with all major indices posting positive returns for the first half of 2023. However, volatility returned in July and August amid strong economic data, a US downgrade, and a weakening Chinese economy.
Fixed Income Index Total Returns
2022 Fixed Income Indexing Flows by Sub Sector
2022 Fixed Income Indexing Flows by Channel
Historically, the fixed income market has been less organized and more fragmented than equity markets, hampering progress seen in other asset classes from advancements and innovations, but thankfully this is quickly changing. Post the Global Financial Crisis (GFC), we have seen improved pricing transparency for investors through the proliferation of electronic trading, which enables more efficient and reliable implementation of fixed income strategies, thereby accelerating the adoption of indexing while paving the way for new approaches such as systematic active fixed income. This alignment of transparency and technology is behind a major consideration among investors on how to best access, construct, and implement their fixed income exposures today.
One key trend gaining traction on the heels of these improved implementation efficiencies is the disaggregation of traditional core/aggregate strategies into their underlying sectors and maturity buckets as discrete building blocks. Increasingly, we are seeing investors “dis-aggregating the Agg” and reconstructing it to better deliver on their various investment objectives for fixed income. This often involves adopting two different, but complementary approaches that can solve for competing objectives such as alpha vs. beta, liquid vs. illiquid, growth vs. matching, public vs. private, etc. Clearly, no manager can be the best at all of these strategies, so we see investors employing specialist active managers as satellites, that are complemented by a reliable, transparent index manager for their core. At State Street Global Advisors we have been designing and delivering this building block approach to fixed income exposure management since launching our first aggregate strategy back in 1995. Today, we have over 100 sub-strategies/building blocks ranging from liquid Treasuries, to more complex sectors such as high yield and emerging market debt. Our success to date is built on delivering these benefits to our investors consistently over many years, and now as more investors come to appreciate and rely on this more outcome-oriented approach, we believe that we are well positioned to partner with them and help achieve their desired outcomes.
As always, we value your business and look forward to our continued partnership in 2023 and beyond. Should you have any additional questions surrounding your investments or the markets, please do not hesitate to reach out to your client relationship manager.
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Investing involves risk including the risk of loss of principal.
Bonds generally present less short-term risk and volatility than stocks, but contain interest rate risk (as interest rates raise, bond prices usually fall); issuer default risk; issuer credit risk; liquidity risk; and inflation risk. These effects are usually pronounced for longer-term securities. Any fixed income security sold or redeemed prior to maturity may be subject to a substantial gain or loss. International government bonds and corporate bonds generally have more moderate short-term price fluctuations than stocks, but provide lower potential long-term returns.
Investing in high yield fixed income securities, otherwise known as “junk bonds,” is considered speculative and involves greater risk of loss of principal and interest than investing in investment grade fixed income securities. These lower-quality debt securities involve greater risk of default or price changes due to potential changes in the credit quality of the issuer.
Investing in foreign domiciled securities may involve risk of capital loss from unfavorable fluctuation in currency values, withholding taxes, from differences in generally accepted accounting principles or from economic or political instability in other nations.
The returns on a portfolio of securities which exclude companies that do not meet the portfolio’s specified ESG criteria may trail the returns on a portfolio of securities which include such companies. A portfolio’s ESG criteria may result in the portfolio investing in industry sectors or securities which underperform the market as a whole.
ETFs trade like stocks, are subject to investment risk, fluctuate in market value and may trade at prices above or below the ETFs net asset value. Brokerage commissions and ETF expenses will reduce returns.
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Exp. Date: 09/30/2024