1. Consider Intermediate Bonds to Balance Yield and Duration
Trillions of negative-yielding debt, rate cuts around the globe, a flat US yield curve and an outsized asymmetric yield and duration profile in the investment-grade global fixed income market make striking a balance between yield and duration a daunting task. Long-term bonds have rallied this year, and current yields could be considered expensive by historical standards. Having traded below the zero bound, the real rate on 10-year bonds now sits 131 basis points below its 36-month exponential moving average.1 If there is a slight mean reversion in yields, low-yielding long-term bonds may present uncompensated duration risks.
Fund in Focus:
SPDR® Portfolio Intermediate Term Corporate Bond ETF [SPIB]
Given the late-cycle dynamics that have sparked episodic volatility and a flat-skewed curve with term premiums at their lowest level since 1961,2 consider the SPDR® Portfolio Intermediate Term Corporate Bond ETF [SPIB], which offers the potential for increased income and return without adding uncompensated duration or equity-like risks. As shown above, the yield earned on the 1-10 year intermediate section of the corporate bond market is higher than the broader corporate market, while only marginally less than long-term corporates. Meanwhile, the larger gap between duration exposures results in a much-improved yield per unit of duration relative to all other segments shown.
2. Look to Preferreds to Improve Liquidity in the Hunt for Yield
With falling interest rates and increasingly accommodative global monetary policy, the hunt for yield has pushed investors to the less liquid corners of the fixed income market. A nonconventional approach for income generation, preferreds yield 60% more and 20% more than investment-grade corporate bonds and large cap stocks, respectively.3 Preferreds' yields are even on par with both emerging market and high yield corporate debt, as shown below. Despite preferreds' potential for higher income generation, these hybrid securities maintain a low correlation to traditional stocks and do not increase a bond portfolio's equity sensitivity relative to other high-yielding credit instruments.
Fund in Focus:
SPDR Wells Fargo® Preferred Stock ETF [PSK]
Investing in single-issue preferreds poses a liquidity challenge. On average, preferred securities within the Wells Fargo Hybrid and Preferred Securities Aggregate Index trade only $1.1 million a day, with bid-ask spreads as wide as 8 cents.4 However, with an ETF, investors can trade both in the robust fixed income secondary market and in the primary market through an Authorized Participant to access preferreds in a more liquid fashion than transacting in the underlying securities. With nearly $1 billion in assets under management, daily trading volumes of over $6 million on average and a bid-ask spread of less than 3 cents,5 the SPDR Wells Fargo Preferred Stock ETF [PSK] covers a diversified basket of 165 preferred securities.6
3. Go Active to Seek Yield While Adding Measured Credit Risk
Given where we are in the cycle, it is important to take measured risks within credit when structuring a high income-producing portfolio. Rate cuts have dampened sentiment toward senior loans as a credit instrument, given their floating-rate nature. However, it may surprise many investors to learn that senior loans, even with the Fed cutting rates twice in 2019, now yield more than fixed rate high yield. There has been less volatility in senior loans' yields over the past year, as well. Additionally, due to the sizable spread compression for fixed rate high yield, it now trades at the most negatively convex level ever –the average price of high yield bonds is $102.1, versus $97.54 for loans.7 This negative convexity indicates an asymmetric return probability with less upside than downside given how tight spreads have become – high yield spreads are more than 30% below their 20-year averages.8
Fund in Focus:
SPDR® Blackstone / GSO Senior Loan ETF [SRLN]
When reaching for yield in an uncertain macro environment, striking a balance between income generation and downside risk mitigation can potentially benefit investors. The actively managed SPDR Blackstone/GSO Senior Loan ETF [SRLN] seeks to avoid the weak or failing credits that would be included in a passive strategy. This makes SRLN a more defensive allocation relative to passive loan or high yield funds.
1 Bloomberg Finance L.P., as of 09/30/2019 based on the 10 Year Yield Adjusted for Core CPI.
2 Bloomberg Finance L.P., as of 09/30/2019 based on the Adrian Crump & Moench 10 Year Treasury Term Premium.
3 Bloomberg Finance L.P., as of 09/30/2019 based on the yield to worst on the Bloomberg Barclays US Corporate Bond Index and the index dividend yield on the S&P 500 High Divided Yield Index.
4 Bloomberg Finance L.P., as of 09/30/2019 based on 60-day average volumes and current bid-ask spread information for the basket of securities.
5 Bloomberg Finance L.P., as of 09/30/2019 based on 60-day average volumes and current bid-ask spread information for the ETF.
6 Bloomberg Finance L.P., as of 09/30/2019. Characteristics are as of the date indicated and are subject to change.
7 S&P Global, Bloomberg Finance L.P., as of 09/30/2019 based on the average price for the ICE BofAML US High Yield Bond Index and the S&P 100 Leveraged Loan Index.
8 Bloomberg Finance L.P., as of 9/30/2019 based on the average price for the ICE BofAML US High Yield Bond Index.
Bloomberg Barclays U.S. Aggregate Bond Index
A benchmark that provides a measure of the performance of the US dollar denominated investment grade bond market, which 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.
Bloomberg Barclays U.S. 1–3 Year Corporate Bond Index
A benchmark designed to measure the performance of the short-term US corporate bond market. It includes publicly issued US dollar-denominated and investment-grade corporate issues that have a remaining maturity of greater than or equal to one year and less than three years.
Bloomberg Barclays U.S. Corporate Bond Index
A fixed-income benchmark that measures the investment-grade, fixed-rate, taxable corporate bond market. It includes USD denominated securities publicly issued by US and non-S industrial, utility and financial issuers.
Bloomberg Barclays U.S. Corporate High Yield Index
A fixed-income benchmark of US dollar-denominated, high-yield and fixed-rate corporate bonds. Securities are classified as high yield if the middle rating of Moody’s, Fitch and S&P is Ba1/BB+/BB+ or below. Bonds from issuers with an emerging markets country of risk, based on Barclays EM country definition, are excluded.
Bloomberg Barclays Intermediate US Corporate Index
A benchmark designed to measure the performance of U.S. corporate bonds that have a maturity of greater than or equal to one year and less than 10 years.
Bloomberg Barclays Long U.S. Corporate Index
Index designed to measure the performance of U.S. corporate bonds that have a maturity of greater than or equal to 10 years.
Bloomberg Barclays U.S. Treasury Index
US Dollar-denominated, fixed-rate, nominal debt issued by the US Treasury. Treasury bills are excluded by the maturity constraint, but are part of a separate Short Treasury Index.
The spread between Treasury securities and non-Treasury securities that are identical in all respects except for quality rating.
A strategy of combining a broad mix of investments and asset class to potentially limit risk, although diversification does not guarantee protecting against a loss in falling markets.
A commonly used measure, expressed in years, that measures the sensitivity of the price of a bond or a fixed income portfolio to changes in interest rates or interest-rate expectations. The greater the duration, the greater the sensitivity to interest rates changes, and vice versa.
S&P 500 Index
A popular benchmark for U.S. large-cap equities that includes 500 companies from leading industries and captures approximately 80% coverage of available market capitalization.
Wells Fargo Hybrid and Preferred Securities Aggregate Index
A modified market-capitalization-weighted benchmark designed to measure the performance of non-convertible preferred stock and securities that are equivalent to preferred stock. Constituents include depositary preferred securities, perpetual subordinated debt and some securities issued by banks and other financial institutions that are eligible for capital treatment.
The income produced by an investment, typically calculated as the interest received annually divided by the investment’s price.
Investing involves risk including the risk of loss of principal.
The information provided does not constitute investment advice and it should not be relied on as such. It should not be considered a solicitation to buy or an offer to sell a security. It does not take into account any investor’s particular investment objectives, strategies, tax status or investment horizon. You should consult your tax and financial advisor.
Bonds generally present less short-term risk and volatility than stocks, but contain interest rate risk (as interest rates rise, 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.
Investments in mortgage securities are subject to prepayment risk, which can limit the potential for gain during a declining interest rate environment and increase the potential for loss in a rising interest rate environment. The mortgage industry can also be significantly affected by regulatory changes, interest rate movements, home mortgage demand, refinancing activity, and residential delinquency trends.
Non-diversified funds that focus on a relatively small number of securities tend to be more volatile than diversified funds and the market as a whole.
Actively managed funds do not seek to replicate the performance of a specified index. An actively managed fund may under perform its benchmark. 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.
Diversification does not ensure a profit or guarantee against loss.
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The funds presented here in have different investment objectives, costs and expenses. Each fund is managed by a different investment firm, and the performance of each fund will necessarily depend on the ability of their respective managers to select portfolio investments. These differences, among others, may result in significant disparity in the funds’ portfolio assets and performance. For further information on the funds, please review their respective prospectuses.