Ken Purnell, CFA®
Head of Asset-Backed Securities Portfolio Management
Invesco Fixed Income
PowerShares by Invesco has always offered fixed-income products that operate within unique niches—particularly within the floating-rate debt space. In fact, PowerShares offers an extensive suite of floating-rate exchange-traded funds (ETFs). Here, we speak with Ken Purnell, who manages the firm’s PowerShares Variable Rate Investment Grade Portfolio (VRIG), about how the fund is managed and what makes it so different from its competitors.
Let’s start by looking at the current market backdrop. Is this a favorable market for floating-rate securities?
Oh, I think very much so. The Federal Reserve (Fed) is now in monetary tightening mode, and as a result, the yield curve has flattened considerably. In fact, since the Fed began hiking short-term rates, the curve from Libor to 10-year Treasuries has flattened by 118 basis points.
An investor in floating-rate securities would normally have to accept a much lower yield than one can get with fixed-rate bonds, but that’s no longer the case now that the curve has flattened. If rates rise, the price decline in floaters is minimal, but with fixed-rate bonds, it can be significant. And keep in mind that fixed rates are still at low levels on a historical basis, so there’s plenty of precedent for them to increase.
Would you discuss the scope of the PowerShares’ fixed-income lineup, particularly regarding floating-rate products?
PowerShares has a wide array of fixed-income ETF offerings covering many asset classes, from municipals to bank loans. Particularly relevant to the floating-rate segment, where we think there’s good value given the market dynamics that currently exist, PowerShares has several different offerings. Our largest variable-rate ETF is the PowerShares Senior Loan Portfolio (BKLN)—a floating-rate bank loan fund that seeks to replicate the S&P/LSTA U.S. Leveraged Loan 100 Index.
Another popular product is the PowerShares Variable Rate Preferred Portfolio (VRP), which is the only ETF that provides dedicated passive exposure to variable-rate preferred securities. This segment of the market has done extremely well this year. The underlying index of VRP seeks to produce a competitive yield, and has the potential to maintain a lower-duration profile than purely fixed-rate preferred ETFs when rates are rising.
Our newest offering in the high-grade floating-rate space is the fund that the Invesco Fixed Income team manages: the PowerShares Variable Rate Investment Grade Portfolio (VRIG). It was launched in September 2016, and now has more than $100 million in assets under management. VRIG is a high-grade actively managed ETF. Our goal is to generate a competitive yield with relatively high credit quality and a very low duration.
PowerShares is an innovator in the marketplace. What’s your process for developing fixed-income products?
We start by looking for voids in the market. I believe VRIG is a good example. Before launching VRIG, the landscape for floating-rate note funds consisted primarily of index-oriented high-grade floating-rate funds tracking the same Bloomberg index. We wanted to create something that offered a higher yield potential than existing competitors—anchored by a high-grade floating-rate sector allocation, but with similar duration and credit-quality characteristics.
The other end of the floating rate spectrum from a credit risk perspective is bank loans, where we have a very competitive product, BKLN. Bank loans tend to offer higher yields, but are often lower on the credit spectrum than investment-grade credits and variable-rate preferreds.
In the case of VRIG, we saw an opportunity to do something that covered a middle ground—close-to-the-benchmark high-grade credit quality, but with a significantly higher yield potential. We create that higher yield potential by virtue of sector diversification and active management.
Does sector diversification in fixed income matter as much as it does in equities? Does its importance change at all within a high-grade portfolio?
Yes, I think sector diversification does matter. When you look at high-grade fixed-income funds in general, there are a number of different ways to generate alpha—meaning above-market returns—relative to a benchmark. Those include manipulating duration, credit risk profiles, sector allocations and security selection in general. Sector allocation typically accounts for a significant source of return generation in high-grade portfolios.
Even within high-grade portfolios, we normally see spread correlations among sectors that are well below 1.0, and sometimes even negative. The benefits of diversification can therefore be quite significant. We feel that using the full suite of fixed-income high-grade sectors—and a mix of maturities—allows the portfolio management team to create a more compelling product. This results in a fund that potentially offers a higher yield, comparable volatility and a similar overall quality rating than a concentrated index-oriented portfolio might be able to offer.
Would you talk a little more about short-duration debt in the current environment?
The ultra-short bond category has seen very strong inflows this year. Short-duration funds tend to be an attractive option when investors feel the valuation levels of riskier assets are stretched and desire a safer place to keep their savings. With fixed rates at the lower end of historical levels, and U.S. equities at or near all-time highs, one can argue that valuations on risky assets are rich, and that now is a prudent time to reduce risk in portfolios, especially for investors who have shorter-term time horizons.
Furthermore, the flattening of the yield curve makes the normal opportunity cost (in terms of yield) of owning short-duration versus longer-duration bond funds much lower now that short rates have come up and longer rates have declined. We feel that in this environment, VRIG, in particular—with its competitive yield and high-grade credit quality—should be considered a significant component of a defensive investment strategy. With VRIG as a key component of our floating-rate lineup, we feel PowerShares offers investors a complete set of solutions for their fixed-income allocation.