A Letter From Our CIO: Fixed Income Index Update
We continue to utilize our deep insights into market structure, liquidity, and risk in order to navigate aggressive monetary policy, volatility, and heightened inflation.
Amid challenging geopolitical and economic environments, fixed income markets registered some of their worst returns on record in the first half of 2022. Our investment process proved resilient despite the challenging market environment, with 99.6%1 of our indexed funds performing within their pre-set tracking bands. Our portfolio managers and traders continuously adhere to our rigorous risk-control process, ensuring client cash flow requirements are met while also minimizing tracking risk (Figure 1).
| Bloomberg Composite/Index | Composite Return (6M) | Index Return (6M) |
Excess Return |
| US Aggregate | -10.34 | -10.35 | 0.01 |
| 1-3 US Credit | 3.27 | -3.35 | 0.08 |
| 3-10 US Credit | -10.58 | -10.56 | -0.02 |
| Long US Credit* | -20.60 | -20.60 | 0.00 |
| 1-3 US Treasuries | -3.01 | -3.01 | 0.00 |
| 3-10 US Treasuries | -7.72 | -7.73 | 0.01 |
| Long US Treasuries | -21.26 | -21.25 | -0.01 |
| US Inflation Linked | -8.91 | -8.92 | 0.01 |
| US High Yield | -14.51 | -14.79 | 0.28 |
| Emerging Markets - Local | 14.10 | -14.53 | 0.43 |
Source: SSGA, Bloomberg as of 06/30/2022.
Past performance does not guarantee future results.
*Performance calculated as of 01/04/2022 – 06/30/2022 due to an industry-wide pricing issue on 12/31 that affected longer-dated credit products.
A notable shift from 2021, credit sectors lagged US Treasuries as a result of slowing growth and decreased demand, leading to a widening in credit spreads to mid-2020 levels. Corporate issuance, hindered by the Fed’s aggressive monetary stance, fell substantially from 2021’s levels, with investment grade issuance down 15% and high yield issuance down 75% versus the prior year.
The substantial rise in Treasury yields across the curve during the first quarter of the year was particularly painful for fixed income investors, as the low interest rate environment of the past few years translated to minimal income to offset price losses. Nevertheless, while price returns across the board continue to be discouraging, investors are now getting more income from their fixed income than they have in quite some time. Current yield levels in most of the major fixed income sectors are either at 10-year highs or at the higher end of these ranges (Figure 2.)
Figure 2: Yield Levels Look More Attractive Today Relative to Long-Term History
For many investors, the higher yields in fixed income today offer a welcome change from the levels of the past decade. Corporate defined-benefit pension plans will want to take the opportunity to de-risk given high funded ratios, while public pensions can get closer to their target long-term returns with diversified fixed income allocations .
The fixed income team continued to see positive flows in the first half of 2022, even amid current market volatility. We saw a total of $9.6 billion of inflows for the period, where both institutional and ETF allocations showed a strong preference for longer-dated government securities as clients looked to extend duration and lock in higher coupons. In addition, we have seen an upsurge in inquiries for short US TIPS strategies as clients look to hedge against the negative effect inflation has had on their fixed income allocations.
Evolution and Innovation in Fixed Income Markets
A notable trend we have witnessed within fixed income is the ever-increasing adoption of electronic trading systems and novel trading techniques such as portfolio trading and all-to-all trading. These developments have substantially transformed fixed income markets over the past few decades from its traditional opaqueness and have allowed for greater insights into liquidity data and pricing, in addition to faster and more efficient access to market liquidity.
The consolidation of bids and offers by electronic trading platforms expands the number of potential interested counterparties, contributing to better pricing and lower transaction costs. Approximately 10 years ago, MarketAxess started publishing its Bid-Ask Spread Index (BASI) as an indicator of market liquidity.2 A daily calculated index based on TRACE3 data, BASI tracks the difference between bids and asks on actively traded corporate bonds over time. As shown in Figure 3, bid-ask spreads are trending downward as electronic trading gains more traction, with some back-ups in times of increased market volatility.
Figure 3: The Decrease of Bid-Ask Spreads
These fixed income market efficiencies positively impact investors in the following ways:
- Expanded network access instantaneously creates opportunities for improved matches between buyers and sellers.
- Improved matches mean better prices – for both buyers and sellers – which means lower costs to access liquidity.
- More data and better liquidity translates to more opportunities for data-based players to quickly squeeze out mis-pricings.
Looking forward, as market efficiencies continue to pressure excess return opportunities, beta decisions rather than security selection will likely drive fundamentally based excess returns. Data and technology are creating new opportunities for both indexing and data-driven, systematic approaches to thrive in an information-rich environment.
Conclusion
State Street Global Advisors will continue to utilize our deep insights into market structure, liquidity, and risk in order to navigate aggressive monetary policy, volatility, and heightened inflation. As always, we are grateful for your business and trust and look forward to our continued partnership.