A Multi-Sector Response to Low Rates in 2021 | Lord Abbett
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Market View

With U.S. Treasury yields remaining near multi-year lows, income investors may wish to consider a multi-sector bond strategy. Here’s why.

Read time: 3 minutes

With yields on U.S. Treasury securities still near all-time lows, investors are having a hard time finding sources of income and total return in the bond market.  While the yield on the 10-year Treasury note has backed up to just above 1%, the “real” (inflation-adjusted) yields on 5-, 10-, and 30-year Treasuries (as measured by Treasury inflation-protected securities, or TIPS) are negative, based on data from Bloomberg.

This environment creates difficulties for core bond investors: not only has the average yield in the Bloomberg Barclays U.S. Aggregate Bond Index (which is largely composed of government and government-related securities) declined, the effective duration has extended over time.  With an average yield of 1.1% and a 6.2-year duration on the “Agg,” core bond investors are left with very little income, but significant duration exposure if rates rise (see Figure 1).  In fact, a small uptick in 10-year yields in the first full week of the new year has led to a nearly 1% loss in the Aggregate Index.

 

Figure 1. Core Bond Yields Have Declined as Duration Has Extended
Duration and yield of the Bloomberg Barclays U.S. Aggregate Bond Index, January 31, 2001–December 31, 2020

Source: Bloomberg Index Services Limited. Data as of December 31, 2020 (latest month-end).

Past performance is not a reliable indicator or guarantee of future results. The historical data are for illustrative purposes only, do not represent the performance of any specific portfolio managed by Lord Abbett or any particular investment, and are not intended to predict or depict future results. Indexes are unmanaged, do not reflect the deduction of fees or expenses, and are not available for direct investment.

 

How might investors respond? We believe there are better opportunities in more credit-sensitive parts of the market, such as investment grade corporate bonds, high yield bonds, bank loans, and emerging market debt. Not only do these sectors provide higher income, historically they have consistently generated higher total returns. Figure 2 summarizes the results of rolling five-year returns: investment grade corporate, high yield, and emerging market bonds have outperformed the Aggregate index in 83%, 80%, and 97% of the respective periods under observation.

 

Figure 2. Why Multi-Sector Credit?

Rolling five-year returns relative to the Bloomberg Barclays U.S. Aggregate Bond Index for the indicated dates

1Bloomberg Barclays U.S. Corporate Bond Index. 2ICE BofA U.S. High Yield Index. 3JPM EMBI GD Index.

Source: Bloomberg Barclays, Bloomberg, and Morningstar, Inc. Rolling five year returns as of 12/31/2020. A basis point is one-one hundredth of a percentage point.

For illustrative purposes only. Past performance is not a reliable indicator or guarantee of future results. The value of an investment in fixed-income securities will change as interest rates fluctuate and in response to market movements. As interest rates fall, the prices of debt securities tend to rise. As rates rise, prices tend to fall. Indexes are unmanaged, do not reflect the deduction of fees or expenses, and are not available for direct investment.

 

These sectors have more credit sensitivity--and less interest rate sensitivity--than core bonds.1 Since these sectors have historically had negative correlation with Treasury securities, they can potentially diversify a core bond allocation and tend to perform well during periods of rising Treasury yields.

Potential Applications for Today’s Market

While credit spreads have rallied, we believe the current environment continues to be supportive of credit.

  • With record issuance of high yield and investment grade bonds last year, companies were able to take advantage of access to credit, refinanced debt and reinforced their balance sheets, resulting in record amounts of cash holdings.
  • Corporate America navigated the pandemic quite well: the hit to earnings was not as bad as many had feared, with S&P 500 earnings beating analyst estimates by a wide margin in the second and third quarters of 2020.
  • With successful implementation of COVID vaccines, a re-opening of the U.S. economy and return to strong employment levels could contribute to credit fundamentals in the year to come.
  • Low inflation allows for a continuation of an accommodative stance by the U.S. Federal Reserve, also supportive of credit markets.

One approach to gain exposure to credit: a multi-sector bond strategy that can provide access to opportunities across many segments of the credit markets. A diversified approach can provide higher income and total return potential versus core bonds, with lower volatility than dedicated high-yield strategies. If the economic environment changes, multi-sector strategies offer the flexibility to adjust exposures accordingly.

We’d like to highlight one other compelling feature of the multi-sector approach: By having the ability to invest across investment grade and high yield sectors, such strategies are well suited to take advantage of “Fallen Angels”  which historically have provided very attractive returns relative to other fixed income sectors, particularly during economic recoveries.

A Final Word

Those investors looking to increase income and return potential versus core bonds, or who are looking to take gains from the strong rally in high yield—and reduce credit exposure—may want to consider a flexible multi-sector credit strategy to generate income in a low yield world, while offering some protection in case rates continue to rise from here.

 

1Credit sensitive assets are financial products whose features and characteristics or their secondary market price are vulnerable to changes in economic fundamentals and therefore, underlying credit conditions. Interest sensitive assets are influenced by changes in interest rates. 

 

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 commentary 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.

Treasuries are debt securities issued by the U.S. government and secured by its full faith and credit. Income from Treasury securities is exempt from state and local taxes.

Treasury inflation-protected securities (TIPS) are a type of Treasury security issued by the U.S. government. TIPS are indexed to inflation in order to protect investors from a decline in the purchasing power of their money. As inflation rises, TIPS adjust in price to maintain its real value.

basis point is one one-hundredth of a percentage point.

Correlation is a statistic that measures the degree of association between two variables.

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.

Fallen angels refers to bonds that have been downgraded from investment grade to speculative grade status.

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 represents securities that are SEC-registered, taxable, and dollar denominated. The index covers the U.S. investment grade fixed rate bond market, with index components for government and corporate securities, mortgage pass-through securities, and asset-backed securities. Total return comprises price appreciation/depreciation and income as a percentage of the original investment.

The Bloomberg Barclays U.S. Corporate Bond Index includes all publicly held issued, fixed-rate, nonconvertible investment-grade corporate debt.  The index is composed of both U.S. and Brady bonds.

Bloomberg Barclays Index Information:

Source: Bloomberg Index Services Limited. BLOOMBERG® is a trademark and service mark of Bloomberg Finance L.P. and its affiliates (collectively “Bloomberg”). BARCLAYS® is a trademark and service mark of Barclays Bank Plc (collectively with its affiliates, “Barclays”), used under license. Bloomberg or Bloomberg’s licensors, including Barclays, own all proprietary rights in the Bloomberg Barclays Indices. Neither Bloomberg nor Barclays approves or endorses this material or guarantees the accuracy or completeness of any information herein, or makes any warranty, express or implied, as to the results to be obtained therefrom and, to the maximum extent allowed by law, neither shall have any liability or responsibility for injury or damages arising in connection therewith.

The ICE BofA US High Yield Index tracks the performance of U.S. dollar denominated below investment grade corporate debt publicly issued in the U.S. domestic market.

ICE BofA Index Information:

Source: ICE Data Indices, LLC (“ICE”), used with permission. ICE PERMITS USE OF THE ICE BofA 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 BofA 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, OR ANY OF ITS PRODUCTS OR SERVICES.

The J.P. Morgan Emerging Markets Bond Global Diversified Index (EMBIGD) is a uniquely-weighted version of the J.P. Morgan Emerging Markets Bond Index Global (EMBI Global). It limits the weights of those index countries with larger debt stocks by only including specified portions of these countries’ eligible current face amounts of debt outstanding. The countries covered in the EMBI Global Diversified are identical to those covered by the EMBI Global.

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

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.

The information provided herein is not directed at any investor or category of investors and is provided solely as general information about our products and services and to otherwise provide general investment education.  No information contained herein should be regarded as a suggestion to engage in or refrain from any investment-related course of action as Lord, Abbett & Co LLC (and its affiliates, “Lord Abbett”) is not undertaking to provide impartial investment advice, act as an impartial adviser, or give advice in a fiduciary capacity with respect to the materials presented herein.   If you are an individual retirement investor, contact your financial advisor or other non-Lord Abbett fiduciary about whether any given investment idea, strategy, product, or service described herein may be appropriate for your circumstances.

The opinions in this commentary 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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