Q2 ETF Playbook for Bond Investors
Rate cuts on the horizon, reinvestment risk, and tight credit spreads will present challenges — and opportunities — as the economy moves toward a soft landing.
Fixed Income Investing Solutions for a Soft Landing
With upbeat economic reports across the globe and continued fundamental earnings durability, the International Monetary Fund (IMF) recently increased its full-year 2024 growth outlook1 — acknowledging for the first time that the global economy has a real chance of pulling off a soft landing.
US economic exceptionalism is fueling the macro momentum that underpins this soft landing scenario. The latest US payroll reports indicate a still-healthy US labor market with ongoing gains in wages. And key gauges of US economic health — GDP, personal spending, and consumer spending — have come in stronger than expected.
Economic resilience outside the US supports the soft landing’s global reach. The eurozone narrowly avoided a technical recession last quarter, as manufacturing data has begun to improve and the recovery in oil prices supports a cyclical upswing. Japan also sidestepped a recession this past quarter, after its economic growth rate was revised upward on the back of much better trade and investment outcomes that offset softer consumer spending. And emerging markets are still projected to have higher earnings growth than developed nations, despite modest revisions over the past few months.2
Rate cuts likely will deliver the final push toward a global soft landing. While Federal Reserve (Fed) Chair Jerome Powell said recently that strong economic growth allows the Fed to wait patiently to cut rates,3 multiple cuts are expected this year from the Fed and other global central banks, except for the Bank of Japan, which is forecast to raise rates a bit off the zero bound.
As monetary policy evolves, supported by strong economic and fundamental foundations, bond investors should seek to:
- Limit reinvestment risk with high quality, stable income solutions that are not greatly impacted by lower short-term rates.
- Boost core bond returns by overlaying credit opportunities, given that the macro and fundamental environment is neither too hot, nor too cold.
Put Cash to Work, Position for Greater Short-term Returns
While supportive growth means fewer rate cuts than previously anticipated, lower short-term rates are expected across the globe by year end (Figure 1). And as the Fed cuts rates, the $1 trillion investors put into ultra-short term money market funds last year4 may be challenged by lower yields and increased reinvestment risk — the process of reinvesting current income streams at lower rates — given the relationship between the central bank’s rates and ultra-short market rates (i.e., Treasury Bills).
Over the past 30 years, as the yield on T-bills began to adjust, so did subsequent 12-month returns (there is a 97% correlation between the two time series).5 And as rates fell precipitously in 2001, 2006, and 2019, the next 12-month returns fell below the stated yield in the current month — due to reinvesting the current income streams at lower rates over the next few months. That’s likely to happen again as the Fed starts to normalize policy in the coming months, possibly as early as June.
Investors facing reinvestment risk can pursue stable income by adopting a total return mindset and laddering further out on the short- to intermediate-duration curve of high quality investment-grade corporate bonds:
- Bonds with maturities between 1 and 3 years that lead to a weighted duration of 1.8 years, but carry a yield in excess of 5%.6 Because that yield is less correlated (71%) to the federal funds rate than ultra-short bonds are,7 the Fed’s cuts won’t impact the yield on a one-to-one basis.
- Bonds with maturities between 1 and 10 years that lead to a weighted duration of 4 years. Lengthening duration even more versus ultra-short markets, but also trimming duration risk (and volatility) relative to broader core bonds, delivers a yield north of 5%.8
Sitting in the short-plus belly portion of the curve allows 1- to 10-year maturity exposures to strike a better balance between yield, duration, and potential volatility from rate movements relative to other corporate bond and Treasury sectors (Figure 2). Versus broad bonds, this better compensates investors for taking on some duration risk to mitigate reinvestment risk.
High Quality Bond ETFs for Reinvestment Risk and Stable Income
To target precise bond sub-sectors offering a potential stable blend of income and duration, consider short-to-intermediate high quality corporate bond ETFs:
- SPDR® Portfolio Short Term Corporate Bond ETF [SPSB], which seeks to track an index of investment-grade corporate bonds with maturities between 1 and 3 years.
- SPDR® Portfolio Intermediate Term Corporate Bond ETF [SPIB], which seeks to track an index of investment-grade corporate bonds with maturities between 1 and 10 years.
Active ETFs can invest beyond these traditional bond sectors, while seeking to maximize the yield-per-unit duration of the portfolio. They can buy a short duration bond sector, like mortgages, which may be screened out under a strict maturity band requirement within broader mandates. This ability to make sector allocation decisions, alongside duration management techniques and security selection, can help reduce the eroding impact of reinvestment risk on bond returns.
For an actively managed short-term bond ETF, consider:
- SPDR® DoubleLine® Short Duration Total Return Tactical ETF [STOT], an actively managed strategy that combines traditional interest rate-sensitive sectors with non-traditional credit-sensitive sectors in a duration-controlled portfolio (between one and three years), to potentially create a high-quality, low-volatility income strategy.
STOT has beaten its benchmark and had top quintile returns within the Morningstar Short-term Bond peer category year to date and over the last one-, two-, and three-year periods.9 And even though it invests in non-traditional credit sensitive sectors, the risk management approach employed by DoubleLine has led to STOT having a lower standard deviation of returns than comparable duration-matched 1-3 year Treasurys over the last one (1.15% versus 1.83%) and three years (2.16% versus 2.24%) — all with a yield nearly 60 basis points (bps) higher (5.26% versus 4.70%).10
Overweight a Credit Bias to Do More for the Core
Core bonds are down this year as improved growth and the expectation for fewer rate cuts have forced the US 10-year yield modestly higher, leading to a slight 1.32% loss for the Bloomberg US Aggregate Bond Index (the Agg).11
But credit has been rewarded amid the conducive economic and fundamental conditions, with high yield corporate bonds and senior loans being two of the best-performing bond sectors so far this year. Investment-grade corporate bonds also have outperformed the Agg year to date, although down on absolute terms. That performance, however, has led to tighter spreads.
For investment-grade corporate bonds, credit spreads are now 35% below their long-term average, and in the bottom quintile over the past 30 years.12 The same trend holds for below investment-grade high-yield bonds; their spreads are 39% below their historical average and are in the lower 11th percentile.13
Tight spreads are not driven by irrational exuberance.
Beyond the economic resilience and fundamental durability, ratings momentum has added further support to credits foundations. While just a tick below one (0.98), the upgrade-to-downgrade ratio has been moving higher after bottoming in Q4 2022 and is now finally back above the historical median (Figure 3) and likely to move higher, adding to the case for a credit overweight.
While subsequent returns have historically been their greatest when spreads are widest, it doesn’t mean returns suffer when spreads are tight. Rather than showing a linear relationship, where returns are lowest when spreads are in the bottom quintile and returns highest when spreads are in the top quintile, returns show more of a “smile” pattern (Figure 4). In fact, quintile one’s (or, today’s) starting spread level returns are higher than quintiles two or three for investment-grade corporates and high yield.
With these tight levels, returns likely won’t be driven from further spread compression, but rather from the carryover of broad core bonds (i.e., credit’s yield advantage), 5.4% for investment-grade corporates and 7.8% for high yield.14 Alongside strong income potential, the strong case for overweighting credit centers on:
- Positive earnings growth supported by ratings momentum, after a string of negative quarters.
- A resilient economy, illustrated by a healthy labor market and upside surprises to GDP figures.
- Looser policy, helping to offset potential re-funding concerns and margin pressures for highly indebted firms.
Active Strategies to Boost the Bond Core
Expressing an overweight to credit can take many forms. Given their increased flexibility to manage duration risks while pursuing opportunities amid a broader universe, actively managed strategies may be the most beneficial approach — both in and out of the core.
For a core strategy that uses active sector allocation and security selection to position opportunistically, helping to generate income and manage risks, consider:
- SPDR® DoubleLine® Total Return Tactical ETF [TOTL], an active core bond exposure that combines traditional and non-traditional fixed income asset classes. TOTL seeks to generate high-quality income by exploiting inefficiencies within the global fixed income market, while maintaining active risk constraints.
TOTL’s approach has led to above benchmark performance this year, as well as over the past one, two, and three years.15 The increased returns have not come with increased risk, however. The portfolios standard deviation of returns is lower across the same time frames, while offering 80 bps more in yield today than the Agg (5.71% versus 4.92%).16
For a more dedicated credit and opportunistic bond fund that seeks higher income streams, while navigating tactical credit opportunities for enhanced alpha, consider: - SPDR® Loomis Sayles Opportunistic Bond ETF [OBND], an actively managed multi-asset credit strategy that may invest in any credit quality across all fixed income sectors, including bank loans and securitized credit instruments.
OBND also may invest throughout the entire maturity curve, with a target portfolio duration between zero to seven years, while using derivatives to tactically adjust risk sensitivities and target mispricings. Since inception in 2021, OBND’s approach has led to 664 bps of cumulative outperformance over the Agg and 132 bps in 2024 alone so far.17 - SPDR Blackstone High Income ETF [HYBL], an actively managed strategy investing in high yield corporate bonds, senior loans, and debt tranches of US collateralized loan obligations (CLOs) seeking to provide high current income with lesser volatility than the general bond and loan segments over a full market cycle.
HYBL currently offers a yield of 7.13%, a potential income stream similar to high yield (7.8%) but with far less volatility (4.3% versus 6.6%) due to the ability to prudently blend different fixed- and floating-rate below investment-grade sectors together.18 And it is in the top quintile versus its Morningstar High-yield Bond peers since its inception in 2021.19
Sticking the Soft Landing
Rate cuts amid strong economic and fundamental foundations present both challenges and opportunities.
As monetary policy evolves, respond to reinvestment risk with short — but not ultra-short — strategies that can help strike a balance between income and stability, while limiting the bite from reinvestment risk on bond returns.
And seek new opportunities within credit, given the yield advantage and positive ratings momentum that support some risk taking. Active strategies that provide more flexibility and increased sector coverage can help overlay a credit bias in portfolios ahead of the expected soft landing.
In all markets, bond ETFs — with their liquidity, transparency, and low costs — can help investors generate income, preserve capital, and manage risks. Stay up to date with fresh insight and education as monetary policy evolves.
TOTL Standard Performance as of March 31, 2024
| QTD | YTD | 1 Year | 3 Year | 5 Year | 10 Year | Since Inception Feb 23, 2015 |
|
|---|---|---|---|---|---|---|---|
| NAV | 0.14% | 0.14% | 2.65% | -1.93% | 0.07% | - | 1.03% |
| Market Value | 0.30% | 0.30% | 2.54% | -1.92% | 0.01% | - | 1.04% |
| Bloomberg U.S. Aggregate Bond Index | -0.78% | -0.78% | 1.70% | -2.46% | 0.36% | 1.54% | 1.17% |
Source: ssga.com, as of March 31, 2024. Inception date: February 23, 2015. Gross Expense Ratio: 0.55%. Past performance is not a reliable indicator of future performance. Investment return and principal value will fluctuate, so you may have a gain or loss when shares are sold. Current performance may be higher or lower than that quoted. Performance of an index is not illustrative of any particular investment. All results are historical and assume the reinvestment of dividends and capital gains. It is not possible to invest directly in an index. Performance returns for periods of less than one year are not annualized. Performance is shown net of fees. Index returns are unmanaged and do not reflect the deduction of any fees or expenses. Index returns reflect all items of income, gain and loss and the reinvestment of dividends and other income as applicable. The market price used to calculate the Market Value return is the midpoint between the highest bid and the lowest offer on the exchange on which the shares of the Fund are listed for trading, as of the time that the Fund's NAV is calculated. If you trade your shares at another time, your return may differ.
OBND Standard Performance as of March 31, 2024
| QTD | YTD | 1 Year | 3 Year | 5 Year | 10 Year | Since Inception Sep 27, 2021 |
|
|---|---|---|---|---|---|---|---|
| NAV | 0.44% | 0.44% | 6.72% | - | - | - | -0.89% |
| Market Value | 0.49% | 0.49% | 6.87% | - | - | - | -0.83% |
| Bloomberg U.S. Aggregate Bond Index | -0.78% | -0.78% | 1.70% | -2.46% | 0.36% | 1.54% | -3.75% |
Source: ssga.com, as of March 31, 2024. Inception date: September 27, 2021. Gross Expense Ratio: 0.55%. Past performance is not a reliable indicator of future performance. Investment return and principal value will fluctuate, so you may have a gain or loss when shares are sold. Current performance may be higher or lower than that quoted. Performance of an index is not illustrative of any particular investment. All results are historical and assume the reinvestment of dividends and capital gains. It is not possible to invest directly in an index. Performance returns for periods of less than one year are not annualized. Performance is shown net of fees. Index returns are unmanaged and do not reflect the deduction of any fees or expenses. Index returns reflect all items of income, gain and loss and the reinvestment of dividends and other income as applicable. The market price used to calculate the Market Value return is the midpoint between the highest bid and the lowest offer on the exchange on which the shares of the Fund are listed for trading, as of the time that the Fund's NAV is calculated. If you trade your shares at another time, your return may differ.
HYBL Standard Performance as of March 31, 2024
| QTD | YTD | 1 Year | 3 Year | 5 Year | 10 Year | Since Inception Feb 16, 2022 |
|
|---|---|---|---|---|---|---|---|
| NAV | 1.88% | 1.88% | 10.90% | - | - | - | 4.08% |
| Market Value | 2.28% | 2.28% | 10.97% | - | - | - | 4.27% |
| Bloomberg U.S. Aggregate Bond Index | -0.78% | -0.78% | 1.70% | -2.46% | 0.36% | 1.54% | -2.42% |
Source: ssga.com, as of March 31, 2024. Inception date: February 16, 2022. Gross Expense Ratio: 0.70%. Past performance is not a reliable indicator of future performance. Investment return and principal value will fluctuate, so you may have a gain or loss when shares are sold. Current performance may be higher or lower than that quoted. Performance of an index is not illustrative of any particular investment. All results are historical and assume the reinvestment of dividends and capital gains. It is not possible to invest directly in an index. Performance returns for periods of less than one year are not annualized. Performance is shown net of fees. Index returns are unmanaged and do not reflect the deduction of any fees or expenses. Index returns reflect all items of income, gain and loss and the reinvestment of dividends and other income as applicable. The market price used to calculate the Market Value return is the midpoint between the highest bid and the lowest offer on the exchange on which the shares of the Fund are listed for trading, as of the time that the Fund's NAV is calculated. If you trade your shares at another time, your return may differ.
STOT Standard Performance as of March 31, 2024
| QTD | YTD | 1 Year | 3 Year | 5 Year | 10 Year | Since Inception Apr 13, 2016 |
|
|---|---|---|---|---|---|---|---|
| NAV | 1.25% | 1.25% | 6.06% | 1.27% | 1.80% | - | 1.78% |
| Market Value | 1.14% | 1.14% | 6.02% | 1.29% | 1.78% | - | 1.80% |
| Bloomberg U.S. Aggregate 1-3 Year Index | 0.45% | 0.45% | 3.56% | 0.26% | 1.31% | 1.27% | 1.32% |
Source: ssga.com, as of March 31, 2024. Inception date: April 13, 2016. Gross Expense Ratio: 0.45%. Past performance is not a reliable indicator of future performance. Investment return and principal value will fluctuate, so you may have a gain or loss when shares are sold. Current performance may be higher or lower than that quoted. Performance of an index is not illustrative of any particular investment. All results are historical and assume the reinvestment of dividends and capital gains. It is not possible to invest directly in an index. Performance returns for periods of less than one year are not annualized. Performance is shown net of fees. Index returns are unmanaged and do not reflect the deduction of any fees or expenses. Index returns reflect all items of income, gain and loss and the reinvestment of dividends and other income as applicable. The market price used to calculate the Market Value return is the midpoint between the highest bid and the lowest offer on the exchange on which the shares of the Fund are listed for trading, as of the time that the Fund's NAV is calculated. If you trade your shares at another time, your return may differ.