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Institutional Perspectives

Investors may wish to consider multi-sector credit strategies when evaluating their fixed-income allocations. 

As we highlighted in a recent Market View, we prefer opportunities in credit to taking on duration risk in the current market environment.  Given that the Bloomberg Barclays Aggregate Bond Index – a common benchmark for core bond strategies – is heavily weighted toward long-duration, government-related securities, investors may want to complement their core bond allocations with credit-sensitive bonds.

 

Chart 1. The Benchmark for Core Bond Allocations is High on Duration and Low on Yield
Bloomberg Barclays U.S. Aggregate Bond Index (as of October 31, 2019)

Source: Bloomberg Barclays.  Past performance is not a reliable indicator or guarantee of future results. MBS=Mortage-Backed Security.  CMBS=Commercial Mortgage-Backed Security. ABS=Asset-Backed Security. 1Other refers to sovereign, supranational, and local authorities. 2Represents modified adjusted duration of the Bloomberg Barclays U.S. Aggregate Bond Index. 3Represents yield to maturity of the Bloomberg Barclays U.S. Aggregate Bond Index. Yield to maturity is the rate of return anticipated on a bond if held until it matures.  Duration is a measure of the sensitivity of the price (the value of principal) of a fixed-income investment to a change in interest rates. For illustrative purposes only and does not represent any specific portfolio managed by Lord Abbett or any particular investment.  Indexes are unmanaged, do not reflect the deduction of fees and expenses, and are not available for direct investment.  

 

As shown in Chart 2, credit-sensitive sectors such as investment-grade corporate bonds, high-yield bonds, and bank loans have historically had low or negative correlation to government securities, potentially providing valuable portfolio diversification benefits to investors’ core bond holdings.

 

Chart 2. Historically, Credit-Sensitive Sectors Have Had a Low Correlation to U.S. Government Securities
Correlation with Bloomberg Barclays U.S. Government Index (July1, 2009–June 30, 2019)

1Bloomberg Barclays U.S. Aggregate Bond Index. 2Bloomberg Barclays U.S. Treasury TIPS Index. 3Bloomberg Barclays U.S. Corporate Baa-Rated Index. 4 ICE BofAML 1-3 Year BBB-Rated U.S. Corporate Index  5Bloomberg Barclays U.S. Corporate High Yield Index. 6S&P 500®Index. 7ICEBofAML All Convertibles All Qualities Index. 8Credit Suisse Leveraged Loan Index.
Source: Morningstar. Past performance is not a reliable indicator or guarantee of future results. Correlation is a statistic that measures the degree of association between two variables. For illustrative purposes only and does not represent any specific portfolio managed by Lord Abbett or any particular investment.  Indexes are unmanaged, do not reflect the deduction of fees and expenses, and are not available for direct investment.  

 

Chart 3. In a Low-Yield Environment, Non-Core Sectors May Provide Opportunities for Higher Income and Total Return Potential
Selected fixed-income index yields (as of September 30, 2019)

1Bloomberg Barclays U.S. Government Index. 2Bloomberg Barclays Investment Grade CMBS Index. 3Bloomberg Barclays U.S. MBS Index. 4Bloomberg Barclays U.S. Corporate Baa-Rated Index. 5J.P. Morgan CEMBI Investment Grade. 6J.P.Morgan CEMBI Non-Investment Grade Index. 7Credit Suisse U.S. High Yield Index. 8Credit Suisse Leveraged Loan Index. Past performance is not a reliable indicator or guarantee of future results. For illustrative purposes only and does not represent any specific portfolio managed by Lord Abbett or any particular investment.  Indexes are unmanaged, do not reflect the deduction of fees and expenses, and are not available for direct investment.  

 

We believe there is still opportunity in U.S. high yield bonds. With many economic indicators pointing to steady U.S. growth, along with the possibility of additional help from what appears to be a very accommodative U.S. Federal Reserve policy, we believe U.S. high yield has the potential to continue to perform well.  However, given the age of the current economic cycle, some investors are hesitant about investing in a pure high-yield mandate.

Those who may not want a full allocation to U.S. high yield may wish to consider a more diversified multi-sector strategy that includes an allocation to U.S. high yield, as well as U.S. investment-grade corporate bonds, U.S. securitized products, and U.S. government-related securities.  Indeed, history has shown that bond market returns by sector can vary quite a bit year by year (see Table1), depending on the economic environment. As such, investors may benefit from a diversified portfolio with the flexibility to invest across multiple asset classes, and that can adapt the portfolio positioning for the market environment.

 

Table 1. Bond Market Returns by Sector Can Vary Year by Year
Annual returns of selected Bloomberg Barclays Indices (2008-November 22, 2019)

Source: Bloomberg Barclays Live and Credit Suisse. Sector returns shown are Bloomberg Barclays Indices as follows: U.S. Aggregate Bond Index, U.S. MBS Fixed Rate Index, U.S. Corporate Investment Grade Index, Municipal Bond Index, U.S. Corporate High Yield Index, U.S. Treasury Index, U.S. TIPS Index, ABS Index, and U.S. Agency Index. Credit Suisse Leveraged Loan Index used for leveraged loans. Past performance is not a reliable indicator or guarantee of future results. Current performance may be higher or lower than the performance data quoted. This historical table is an illustration of the most commonly used indexes representative of various sectors of the bond market and does not depict or predict the performance of any specific portfolio managed by Lord Abbett or any particular investment. Please note not all sectors are represented nor is this an asset allocation recommendation. Indexes are unmanaged, do not reflect the deduction of fees or expenses, and are not available for direct investment.

 

A Multi-Sector Approach
A multi-sector approach may allow investors to participate in a potentially positive environment for high yield, but with the flexibility to adjust allocations to react to shifts in the market.  Such an approach offers the potential to deliver higher income and total return than traditional core bond strategies, in our opinion, with the possibility of much lower volatility than pure high-yield strategies, while providing diversification for investors’ fixed income allocations.

 

A Note about Risk: The value of investments in fixed-income securities will change as interest rates fluctuate and in response to market movements. Generally, when interest rates rise, the prices of debt securities fall, and when interest rates fall, prices generally rise. High-yield securities, sometimes called junk bonds, carry increased risks of price volatility, illiquidity, and the possibility of default in the timely payment of interest and principal. Bonds may also be subject to other types of risk, such as call, credit, liquidity, interest-rate, and general market risks. Longer-term debt securities are usually more sensitive to interest-rate changes; the longer the maturity of a security, the greater the effect a change in interest rates is likely to have on its price. Lower-rated bonds may be subject to greater risk than higher-rated bonds. No investing strategy can overcome all market volatility or guarantee future results.

Statements concerning financial market trends are based on current market conditions, which will fluctuate. There is no guarantee that markets will perform in a similar manner under similar conditions in the future.

Forecasts and projections are based on current market conditions and are subject to change without notice. Projections should not be considered a guarantee.

This article may contain assumptions that are “forward-looking statements,” which are based on certain assumptions of future events. Actual events are difficult to predict and may differ from those assumed. There can be no assurance that forward-looking statements will materialize or that actual returns or results will not be materially different from those described here.

Glossary

An Asset-Backed Security is a security whose income payments and hence value are derived from and collateralized by a specified pool of underlying assets, such as loans, leases, credit card debt, royalties, or receivables. 

A Commercial Mortgage-Backed Security is a type of mortgage-backed security backed by commercial mortgages rather than residential real estate. 

A Mortgage-Backed Security is a type of asset-backed security which is secured by a mortgage or collection of mortgages.

A basis point is one hundredth of one percent.

Correlation is a statistic that measures the degree to which two securities move in relation to each other. A perfect positive correlation means that the correlation coefficient is exactly 1. This implies that as one security moves, either up or down, the other security moves in lockstep, in the same direction. A perfect negative correlation means that two assets move in opposite directions, while a zero correlation implies no relationship at all.

The yield to worst (YTW) is the lowest potential yield that can be received on a bond without the issuer actually defaulting.

The Bloomberg Barclays U.S. Aggregate Bond Index is an unmanaged index composed of investment-grade securities from the Bloomberg Barclays Government/Corporate Bond Index, Mortgage-Backed Securities Index and the Asset-Backed Securities Index.

The Bloomberg Barclays U.S. Mortgage-Backed Securities (MBS) Fixed Rate Index is the U.S. MBS component of the U.S. Aggregate index. The MBS Index covers the mortgage-backed pass-through securities of Ginnie Mae (GNMA), Fannie Mae (FNMA), and Freddie Mac (FHLMC).

The Bloomberg Barclays U.S. Corporate Investment Grade Index is the corporate component of the U.S. Credit index. The U.S. Credit index is defined as publicly issued U.S. corporate and specified foreign debentures and secured notes that meet the specified maturity, liquidity, and quality requirements. To qualify, bonds must be SEC-registered. The index includes both corporate and non-corporate sectors. Bonds must be an investment grade credit security and have at least $250 million par amount outstanding.

The Bloomberg Barclays Municipal Bond Index is a rules-based, market-value-weighted index engineered for the long-term tax-exempt bond market.  Bonds must be rated investment-grade (Baa3/BBB- or higher) by at least two ratings agencies.  They must have an outstanding par value of at least $7 million and be issued as part of a transaction of at least $75 million. The bonds must be fixed rate, have a dated-date after December 31, 1990, and must be at least one year from their maturity date.

The Bloomberg Barclays U.S. Corporate High Yield Index is a market value-weighted index which covers the U.S. non-investment grade fixed-rate debt market. The index is composed of U.S. dollar-denominated corporate debt in Industrial, Utility, and Finance sectors with a minimum $150 million par amount outstanding and a maturity greater than 1 year. The index includes reinvestment of income.

The Bloomberg Barclays U.S. Treasury Index is the U.S. Treasury component of the U.S. Government Index. The index includes public obligations of the U.S. Treasury with a remaining maturity of one year or more.

The Bloomberg Barclays U.S. TIPS Index is an unmanaged index comprised of U.S. Treasury Inflation Protected Securities with at least $1 billion in outstanding face value.

The Bloomberg Barclays Asset-Backed Securities (ABS) Index is the U.S. ABS component of the U.S. Aggregate index.

The Bloomberg Barclays U.S. Agency Index is a component of the U.S. Government index.

The Bloomberg Barclays U.S. Government Index is a market value-weighted index composed of all publicly issued, nonconvertible, domestic debt of the U.S. government or any agency thereof, quasi-federal corporations, or corporate debt guaranteed by the U.S. government.

The Bloomberg Barclays Investment Grade CMBS Index measures the market of conduit and fusion CMBS deals with a minimum current deal size of $300 million.

The Bloomberg Barclays U.S. Corporate Baa-Rated Index is the Baa-rated component of the U.S. Corporate Investment Grade index.

The Bloomberg Barclays U.S. Corporate High Yield Index is a market value-weighted index which covers the U.S. non-investment grade fixed-rate debt market. The index is composed of U.S. dollar-denominated corporate debt in industrial, utility, and finance sectors with a minimum $150 million par amount outstanding and a maturity greater than one year.

The Credit Suisse Leveraged Loan Index is designed to mirror the investable universe of the U.S. dollar-denominated leveraged loan market.

The Credit Suisse U.S. High Yield Index is an unmanaged, trader-priced index constructed to mirror the characteristics of the high-yield market. The index includes issues rated BB and below by S&P or Moody’s, with par amounts greater than $75 million.

The ICE BofAML All Convertibles All Qualities Index contains issues that have a greater than $50 million aggregate market value. The issues are U.S. dollar-denominated, sold into the U.S. market and publicly traded in the United States.

The ICE BofAML 1-3 Year BBB U.S. Corporate Index is a subset of the ICE BofAML 1-3 Year U.S. Corporate Index including all securities with a remaining term to final maturity less than three years and rated ‘BBB1’ through ‘BBB3,’ inclusive.  

Source:  ICE Data Indices, LLC (“ICE”), used with permission. ICE PERMITS USE OF THE ICE BofAML INDICES AND RELATED DATA ON AN "AS IS" BASIS, MAKES NO WARRANTIES REGARDING SAME, DOES NOT GUARANTEE THE SUITABILITY, QUALITY, ACCURACY, TIMELINESS, AND/OR COMPLETENESS OF THE ICE BofAML INDICES OR ANY DATA INCLUDED IN, RELATED TO, OR DERIVED THEREFROM, ASSUMES NO LIABILITY IN CONNECTION WITH THE USE OF THE FOREGOING, AND DOES NOT SPONSOR, ENDORSE, OR RECOMMEND LORD, ABBETT & CO. LLC., OR ANY OF ITS PRODUCTS OR SERVICES.

The J.P. Morgan Corporate Emerging Markets Bond Index (CEMBI) Investment Grade is a market capitalization weighted index that tracks total returns of US dollar-denominated debt instruments issued by investment-grade corporate entities in emerging markets countries.

The J.P. Morgan CEMBI Non-Investment Grade is a market capitalization weighted index that tracks total returns of US dollar-denominated debt instruments issued by non-investment-grade corporate entities in emerging markets countries.

The S&P 500® Index is widely regarded as the standard for measuring large cap U.S. stock market performance and includes a representative sample of leading companies in leading industries.

The credit quality of the securities are assigned by a nationally recognized statistical rating organization (NRSRO), such as Standard & Poor's, Moody's, or Fitch, as an indication of an issuer's creditworthiness. Ratings range from 'AAA' (highest) to 'D' (lowest). Bonds rated 'BBB' or above are considered investment grade. Credit ratings 'BB' and below are lower-rated securities (junk bonds). High-yielding, non-investment-grade bonds (junk bonds) involve higher risks than investment-grade bonds. Adverse conditions may affect the issuer's ability to pay interest and principle on these securities.

Indexes are unmanaged, do not reflect the deduction of fees or expenses, and are not available for direct investment.

The information provided is not directed at any investor or category of investors and is provided solely as general information about Lord Abbett’s products and services and to otherwise provide general investment education. None of the information provided should be regarded as a suggestion to engage in or refrain from any investment-related course of action as neither Lord Abbett nor its affiliates are undertaking to provide impartial investment advice, act as an impartial adviser, or give advice in a fiduciary capacity. If you are an individual retirement investor, contact your financial advisor or other fiduciary about whether any given investment idea, strategy, product or service may be appropriate for your circumstances.

The opinions in this article are as of the date of publication, are subject to change based on subsequent developments, and may not reflect the views of the firm as a whole. The material is not intended to be relied upon as a forecast, research, or investment advice, is not a recommendation or offer to buy or sell any securities or to adopt any investment strategy, and is not intended to predict or depict the performance of any investment. Readers should not assume that investments in companies, securities, sectors, and/or markets described were or will be profitable. Investing involves risk, including possible loss of principal. This document is prepared based on the information Lord Abbett deems reliable; however, Lord Abbett does not warrant the accuracy and completeness of the information. Investors should consult with a financial advisor prior to making an investment decision.

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