Bond Compass

How to Choose Bond ETFs for What Comes Next

Federal Reserve (Fed) policymakers have signaled more rate hikes are on the horizon.¹ But traders are forecasting rate cuts,²with the first occurring as early as the third quarter.

Q2 2023

April 27, 2023

These opposing views have added to elevated bond volatility. Implied volatility levels are averaging in the historical 90^thpercentile³ and realized volatility is at 35-year highs.⁴

Similarly, contradictory forces are at play within credit; spreads are below long-term averages,⁵ even though ratings downgrades have outpaced upgrades for three consecutive quarters.⁶

In this environment, active core strategies can help position portfolios for any volatility following a pivot in rates. And, short-duration's elevated yields offer income while minimizing total risks. Meanwhile, select credit exposures may help you navigate murky fundamentals.

Get Active in Your Bond Core to Maximize Total Return

Today’s uncertain path for monetary policy and mixed fundamentals call for active core strategies. By combining traditional and non-traditional fixed income asset classes to maximize total return over a full market cycle, active sector allocation and security selection can potentially better defend against rate and credit risk than core aggregate bonds.

Why TOTL

Actively managed by DoubleLine Capital, the SPDR® DoubleLine® Total Return Tactical ETF’s (TOTL) rolling six-month returns analysis versus its peer group median highlights the fund’s defensive qualities:

82% lower correlation to stocks
92% less volatility
90% lower drawdowns⁷

Core bonds are more volatile than ever, with the 90-day realized volatility of the Bloomberg US Aggregate Bond Index back over 8% and in the 99^th percentile over the last 35 years, as shown below. These levels surpass the Great Financial Crisis and onset of the COVID-19 pandemic, which makes reducing volatility in the largest part of your bond portfolio even more important today.

High-quality, uncorrelated assets also can help defend against losses during periods of rate and equity volatility. TOTL combines traditional bond sectors found in the Agg with credit-sensitive sectors, like high yield corporates and bank loans. And, the fund’s embedded mortgage bias enhances its credit quality as these securities are backed by the federal government.

With 76% exposure to investment-grade rated debt, 60% of the fund is AAA⁸ rated. This puts TOTL in the 8^th percentile of its peers and 19 percentage points higher than the peer group median allocation.⁹TOTL has both mitigated volatility and been a source of returns, outperforming its benchmark and 83% of its peers over the past year.¹⁰

If you’re looking to insulate the largest part of your bond portfolio from elevated volatility while pursuing return opportunities in this inefficient market — consider the actively managed TOTL.

TOTL Performance

	QTD	YTD	1 Year	3 Year	5 Year	10 Year	Since Inception
NAV	3.25%	3.25%	-4.36%	-1.76%	0.30%	-	0.83%
Market Value	3.30%	3.30%	-4.05%	-1.68%	0.34%	-	0.86%
Bloomberg U.S. Aggregate Bond Index	2.96%	2.96%	-4.78%	-2.77%	0.91%	1.36%	1.10%

Inception date: February 23, 2015. Source: State Street Global Advisors, as of March 31, 2023.

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.

Gross Expense Ratio: 0.55% Net Expense Ratio: 0.55%

The gross expense ratio is the fund’s total annual operating expenses ratio. It is gross of any fee waivers or expense reimbursements. It can be found in the fund’s most recent prospectus.

Focus On High Rates in Short-Duration Markets for Better Balance

One more rate hike is forecasted for the rest of the year. Whether that happens or not, what is clear is that the Fed is closer to the end of its policy aggressiveness than the beginning. Nevertheless, its actions have created above-average income opportunities within short duration markets, the segment most sensitive to Fed policy.

For example, 1–3 year US investment-grade corporate bonds — now yielding 5%, more than 200 basis points (bps) above their 20-year average — are particularly attractive.¹¹

While rates have risen for 1-3 year investment-grade corporate bonds, duration has remained steady at 1.83 years, on par with its 20-year average.¹² As a result of the rise in yields but stasis in rate risk, 1-3 year corporates’ yield-per-unit-of-duration is 2.7, in the 99^th percentile over the past 10 years.¹³

No other credit related maturity band saw such a significant improvement in this yield versus rate risk ratio, as shown below. And with credit spreads near their long-term average, the extra yield doesn’t come from outsized credit risk.

Why SPSB

The SPDR® Portfolio Short Term Corporate Bond ETF (SPSB), a fund covering the 1-3 year investment-grade segment with an index-weighted average rating of A3/BAA1,¹⁴ represents a high-quality value opportunity to pick up a yield on par with the US equity market earnings yield of 5.3%.¹⁵

And because of the shape of the curve, SPSB’s yield is also above the broader US Aggregate bond market’s yield of 4.2%, without any more duration or credit risk than you would have assumed over the past 20 years in this portion of the credit market. SPSB’s return volatility profile is 86%, 55%, and 70% less than that of broad stocks, bonds, and credit markets, respectively.¹⁶

SPSB Performance

	QTD	YTD	1 Year	3 Year	5 Year	10 Year	Since Inception
NAV	1.35%	1.35%	0.47%	0.97%	1.70%	1.46%	1.72%
Market Value	1.42%	1.42%	0.60%	1.03%	1.73%	1.45%	1.73%
Bloomberg U.S. 1-3 Year Corporate Bond Index	1.24%	1.24%	0.36%	1.01%	1.73%	1.59%	2.01%

Inception date: December 16, 2009. Source: State Street Global Advisors, as of March 31, 2023.

Gross Expense Ratio: 0.04% Net Expense Ratio: 0.04%

The gross expense ratio is the fund’s total annual operating expenses ratio. It is gross of any fee waivers or expense reimbursements. It can be found in the fund’s most recent prospectus.

Why ULST

An active ultra-short strategy can access other attractive segments such as securitized credits, asset-backed securities, mortgage-backed securities (MBS), and commercial mortgage-backed securities. The actively managed SPDR® SSGA Ultra Short Term Bond ETF (ULST) invests at least 80% of its assets in a diversified portfolio of US dollar-denominated investment-grade fixed income securities, including up to 10% in high yield.

The fund targets a duration of 1 year or less and a weighted average maturity of 2.5 years or less. Its credit selection and risk management tactics result in ULST offering a higher yield than the broader Agg (SEC Yield of 4.96% versus Agg yield-to-worst of 4.2%),¹⁷ but with 88% less volatility.¹⁸

ULST also produced a positive return in 2022 (+0.84%), as well as over the past 12 months (+2.81%), while outperforming its peer group median manager by 70 bps over the latter time period.¹⁹

For both funds, the exposures, maturity focus, income potential, and volatility profile relative to the broader market can help you strike a better balance between risk and return.

ULST Performance

	QTD	YTD	1 Year	3 Year	5 Year	10 Year	Since Inception
NAV	1.33%	1.33%	2.81%	2.22%	1.73%	-	1.32%
Market Value	1.32%	1.32%	2.86%	2.33%	1.74%	-	1.32%
Bloomberg US Treasury Bellwether 3 Month Index	1.12%	1.12%	2.60%	0.92%	1.43%	0.89%	0.94%

Inception date: October 9, 2013. Source: State Street Global Advisors, as of March 31, 2023.

Gross Expense Ratio: 0.20% Net Expense Ratio: 0.20%

The gross expense ratio is the fund’s total annual operating expenses ratio. It is gross of any fee waivers or expense reimbursements. It can be found in the fund’s most recent prospectus.

Add Selective Credit Strategies to Manage Murky Fundamentals

Downgrades have outnumbered upgrades in the high yield market for three consecutive quarters — the longest streak since 2019.²⁰ Default rates are also expected to be between 3 and 4% over the next 12 months,²¹higher than what we saw in 2021, 2022, and in the three years prior to the pandemic.

Weak earnings trends suggest these projections are justified.

Yet, this negative sentiment hasn’t impaired credit spreads. Currently below long-term averages (478 bps versus 508 bps), credit spreads have compressed by 150 bps since the peak last June,²²leading to borderline unattractive valuations.

Despite these headwinds, below investment-grade credit remains attractive based on its return profile. The yield-to-worst on high yield is 8.5%,²³and history shows that the subsequent 5-year return on high yield bonds has a 91% correlation to the yield at time of purchase, as shown below.²⁴

Additionally, over the past 10 and 20 years, coupons and their reinvestment contributed to more than 100% of high yield’s return — not changes in price.²⁵

Why HYBL

While high yield offers a potentially attractive long-term entry point, it’s being met with mixed fundamentals. An actively managed credit strategy may help to navigate this market where fundamental volatility (uneven earnings trends) is colliding with elevated rate volatility.

The SPDR® Blackstone High Income ETF (HYBL), an actively managed strategy that invests in high yield corporate bonds, senior loans, and debt tranches of US collateralized loan obligations (CLOs), uses a top-down asset allocation approach to determine relative weightings. Coupled with bottom-up security selection, this builds a high-income portfolio with potentially lower volatility than the broader high yield market.

Over its first full year of live performance, HYBL has outperformed a broad high yield benchmark by 250 bps, with 30% less volatility (5.12% versus 7.44%).²⁶

HYBL Performance

	QTD	YTD	1 Year	3 Year	5 Year	10 Year	Since Inception
NAV	3.24%	3.24%	-1.60%	-	-	-	-1.67%
Market Value	3.09%	3.09%	-1.36%	-	-	-	-1.38%
Bloomberg US Aggregate Bond Index	2.96%	2.96%	-4.78%	-2.77%	0.91%	1.36%	-5.96%
SPDR Blackstone High Income Composite Index	3.48%	3.48%	-0.45%	7.21%	3.37%	4.03%	-0.64%

Inception date: February 16, 2022. Source: State Street Global Advisors, as of March 31, 2023.

Gross Expense Ratio: 0.70% Net Expense Ratio: 0.70%

The gross expense ratio is the fund’s total annual operating expenses ratio. It is gross of any fee waivers or expense reimbursements. It can be found in the fund’s most recent prospectus.

What’s Next for Bond Investors

We expect macro policy to continue to impact day-over-day volatility. And fundamentals will likely remain murky until at least the back half of 2023 when growth is forecast to turn positive.

Whatever strategy you settle on to defend against rate and credit risk and pursue yield, check out our Market Trends page for timely analysis, macroeconomic perspectives, and ETF flows data to help you manage portfolios in this challenging environment.

Footnotes

¹Based on the median dot plot from the Federal Reserve resulting in a 5.125% rate versus 5.00% current fed funds rate as of 4/5/2023
²Fed funds futures contracts indicate rate cuts occurring at the September meeting per Bloomberg Finance L.P. as of 4/5/2023
³The average 30-day level of the MOVE Index is in the 90th percentile per Bloomberg Finance L.P. as of 4/5/2023 based on daily data from 1988-2023
⁴Rolling 90-day standard deviation of returns on the Bloomberg US Aggregate Bond Index per Bloomberg Finance L.P. data from 1989-2023
⁵Option Adjusted Spreads for the Bloomberg US High Yield Corporate Bond Index are 478 basis points versus 508 basis points on average from 2003-2023 per Bloomberg Finance L.P. as of 4/5/2023
⁶Based on ratings action from S&P on North American High Yield issuers per Bloomberg Finance L.P. data as of 4/5/2023
⁷Morningstar, 03/01/2015 to 03/31/2023. Analysis is based on rolling six-month returns with a one-month moving step, creating 91 observable periods. Peer group defined as all US-listed ETFs and US domiciled mutual funds (oldest share class) in the Intermediate Core-Plus Morningstar Category. 226 funds analyzed. US equities defined as the S&P 500 Index. Past performance is not a reliable indicator of future performance
⁸ssga.com, as of 02/28/2023.

⁹Morningstar, ssga.com, as of 03/28/2023. Peer group defined as all US-listed ETFs and US domiciled mutual funds (oldest share class) in the Intermediate Core-Plus Morningstar Category.
¹⁰Morningstar, 03/31/2022 to 03/31/2023. Peer group defined as all US-listed ETFs and US domiciled mutual funds (oldest share class) in the Intermediate Core-Plus Morningstar Category. 226 funds analyzed. Past performance is not a reliable indicator of future performance
¹¹Bloomberg Finance, L.P. based on the yield-to-worst for Bloomberg US Corporate 1-3 Year Index from 2002-2023 as of 4/5/2023
¹²Bloomberg Finance, L.P. based on the duration for Bloomberg US Corporate 1-3 Year Index from 2002-2023 as of 4/5/2023
¹³Bloomberg Finance, L.P. based on the yield-to-worst and duration for Bloomberg US Corporate 1-3 Year Index from 2002-2023 as of 4/5/2023
¹⁴Bloomberg Finance, L.P. based on the holdings for Bloomberg US Corporate 1-3 Year Index as of 4/5/2023
¹⁵Bloomberg Finance, L.P. based on the earnings yield for the S&P 500 Index as of 4/5/2023
¹⁶Bloomberg Finance, L.P. based on 5-year standard deviation of returns for the Bloomberg US Corporate 1-3 Year Index versus the S&P 500 Index, the Bloomberg US Aggregate Bond Index, the Bloomberg US Corporate Bond Index as of 4/5/2023
¹⁷Ssga.com as of 4/5/2023 and Bloomberg Finance L.P. as of 4/5/2023
¹⁸Bloomberg Finance, L.P. based on 5-year standard deviation of returns for ULST and the Bloomberg US Aggregate Bond Index as of 4/5/2023
¹⁹Morningstar as of 03/31/2023 Peer group defined as all US-listed ETFs and US domiciled mutual funds (oldest share class) in the Morningstar Ultrashort Bond Category
²⁰Based on ratings action from S&P on North American High Yield issuers per Bloomberg Finance L.P. data as of 4/5/2023
²¹BoFA US High Yield Strategy 3/31/2023
²²Bloomberg Finance, L.P based on the Bloomberg US High Yield Corporate Bond Index as of 4/5/2023
²³Bloomberg Finance, L.P based on the Bloomberg US High Yield Corporate Bond Index as of 4/5/2023
²⁴Bloomberg Finance, L.P based on the Bloomberg US High Yield Corporate Bond Index as of 4/5/2023
²⁵Bloomberg Finance, L.P based on the Bloomberg US High Yield Corporate Bond Index as of 4/5/2023
²⁶Bloomberg Finance, L.P based on HYBL returns and the Bloomberg US High Yield Corporate Bond Index from 02/28/2023 to 03/31/2023

Glossary

Bloomberg US Aggregate Bond Index

A benchmark that provides a measure of the performance of the US dollar-denominated investment-grade bond market. The “Agg” includes investment-grade government bonds, investment-grade corporate bonds, mortgage pass-through securities, commercial mortgage-backed securities and asset-backed securities that are publicly for sale in the US.

Credit Spread
The spread between the yield on a bond and the yield on the equivalent duration matched government bond.

Dispersion
The difference in returns between one asset class or market exposure to another.

Duration
A measure of the sensitivity of the price of a bond or other debt instrument to a change in interest rates.

High Yield
A company or bond that is rated “BB” or lower is known as junk-grade or high yield, in which case, the probability that the company will repay its issued debt is deemed to be speculative.

ICE MOVE INDEX
This is a yield curve weighted index of the normalized implied volatility on 1-month Treasury options

Investment-Grade Credit
A fixed income security, such as a corporate or municipal bond, that has a relatively low risk of default. Bond-rating firms, such as Standard & Poor’s, use different lettered descriptions to identify a bond’s credit quality. In S&P’s system, investment-grade credits include those with “AAA” or “AA” ratings (high credit quality), as well as “A” and “BBB” (medium credit quality). Anything below this “BBB” rating is considered non-investment-grade.

Treasurys
The debt obligations of a national government. Also known as “government securities,” Treasuries are backed by the credit and taxing power of a country, and are thus regarded as having relatively little or no risk of default.

Volatility
The tendency of a market index or security to jump around in price. Volatility is typically expressed as the annualized standard deviation of returns. In modern portfolio theory, securities with higher volatility are generally seen as riskier due to higher potential losses.

Yield
The income produced by an investment, typically calculated as the interest received annually divided by the price of the investment. Yield comes from interest-bearing securities, such as bonds and dividend-paying stocks.

Disclosure

Important Risk Discussion

The views expressed in this material are the views of Matthew Bartolini and through the period ended April 7, 2023 and are subject to change based on market and other conditions. This document contains certain statements that may be deemed forward-looking statements. Please note that any such statements are not guarantees of any future performance and actual results or developments may differ materially from those projected.

Investing involves risk, including the risk of loss of principal.

Diversification does not ensure a profit or guarantee against loss.

This communication is not intended to be an investment recommendation or investment advice and should not be relied upon as such.

The value of the debt securities may increase or decrease as a result of the following: market fluctuations, increases in interest rates, inability of issuers to repay principal and interest or illiquidity in the debt securities markets; the risk of low rates of return due to reinvestment of securities during periods of falling interest rates or repayment by issuers with higher coupon or interest rates; and/or the risk of low income due to falling interest rates. To the extent that interest rates rise, certain underlying obligations may be paid off substantially more slowly than originally anticipated and the value of those securities may fall sharply. This may result in a reduction in income from debt securities income.

All information is from SSGA unless otherwise noted and has been obtained from sources believed to be reliable, but its accuracy is not guaranteed. There is no representation or warranty as to the current accuracy, reliability or completeness of, nor liability for, decisions based on such information, and it should not be relied on as such.

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.

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.

Passively managed funds hold a range of securities that, in the aggregate, approximates the full Index in terms of key risk factors and other characteristics. This may cause the fund to experience tracking errors relative to performance of the index.

Actively managed funds do not seek to replicate the performance of a specified index. An actively managed fund may underperform its benchmarks. An investment in the fund is not appropriate for all investors and is not intended to be a complete investment program. Investing in the fund involves risks, including the risk that investors may receive little or no return on the investment or that investors may lose part or even all of the investment.

TOTL and ULST are actively managed. A sub-adviser’s judgments about the attractiveness, relative value, or potential appreciation of a particular sector, security, commodity or investment strategy may prove to be incorrect, and may cause the fund to incur losses. There can be no assurance that the sub-adviser’s investment techniques and decisions will produce the desired results.

State Street Global Advisors Funds Distributors, LLC is the distributor for certain registered products on behalf of the advisor. SSGA Funds Management has retained DoubleLine Capital LP as the sub-advisor. State Street Global Advisors Funds Distributors, LLC is not affiliated with DoubleLine Capital LP.

The trademarks and service marks referenced herein are the property of their respective owners. Third-party data providers make no warranties or representations of any kind relating to the accuracy, completeness or timeliness of the data and have no liability for damages of any kind relating to the use of such data.

The whole or any part of this work may not be reproduced, copied or transmitted or any of its contents disclosed to third parties without State Street Global Advisors’ express written consent.

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