[This industry perspective is sponsored by Legg Mason.]
Legg Mason recently launched the Western Asset Short Duration Income ETF (WINC), an actively managed short-duration bond ETF. Here, WINC Portfolio Manager Kurt Halvorson talks about what the fund can offer investors, such as the potential for current income, lower costs and reduced rate sensitivity.
Tell us about your new ETF offering, the Western Asset Short Duration Income ETF (WINC). Why was now the right time to launch this ETF?
As interest rates have risen, particularly on the front end of the credit curve, we have seen a dramatic increase in demand for our low-duration high-quality yield products. An ETF vehicle can deliver this strategy to our clients in a quick and efficient manner, so we are very excited about the recent launch of WINC. We think the front end of the credit curve represents an excellent opportunity from a risk/reward standpoint.
Broadly speaking, what investors should know is that WINC is an actively managed, low-duration (0-3 years), fixed-income strategy with a focus on higher credit quality1 and active credit selection. While rates have risen of late, we are still in a historically lower-yielding environment that continues to present challenges for many investors seeking attractive sources of income. The current environment is also marked with a flatter yield curve,2 making shorter-dated bonds attractive from a relative yield and risk/reward perspective.
At this stage of the business and credit cycle, investors should be cognizant of the potential risks associated with reaching for yield. This makes the potential for active fixed-income investing even greater, as passive strategies are beholden to the rules of an index that can dictate the buying and selling within a portfolio. Alternatively, active management can selectively identify opportunities and avoid potential pitfalls.
At Western Asset, we pride ourselves on using intensive propriety research, robust risk management and a strict value discipline to meet our objectives.
This is Western Asset’s second ETF offering in the Legg Mason lineup. Why do you think it’s appealing?
The fund is attractively priced, with an expense ratio of 0.29%, providing its investors with a cost-effective solution to gaining access to actively managed, low-duration, higher-credit-quality fixed income. Investors who are seeking attractive income but are sensitive to interest rate and credit risk may find WINC an appealing option, as it combines these attributes with the traditional benefits of an ETF, including lower cost, intraday liquidity and daily transparency of holdings.
How can it be used in an investor’s portfolio?
WINC can be used in a variety of ways. Firstly, WINC can be used as a complement to a core or core-plus strategy, which could benefit investors who are looking to reduce interest rate risk, or for investors who may be looking to target a specific duration while still maintaining an attractive yield profile.
Secondly, WINC can be an attractive alternative for passive investors who have concerns about the current environment of the credit markets. Passive strategies are subject to forced buying and selling, whereas active management is not subject to the rules of an index and can potentially create additional value by taking advantage of increases in volatility.
Additionally, as we approach the later stages of the credit cycle, there may be investors who are looking to increase the overall credit quality of their portfolios from a bank loan, high-yield or short-term high-yield fund/ETF while still maintaining some yield. WINC can be a very attractive alternative for these types of investors.
And finally, WINC is a competitive option for investors who are looking for a place to invest their cash and are comfortable with taking on some risk to target yield and income potential through active management.
In all, WINC offers vast utility for investors, depending on their specific investment needs.
How is the fund allocated?
WINC typically allocates to investment-grade corporate bonds (at its core), supplemented by opportunistic exposures to other investments such as high-yield bonds, structured securities and emerging market debt. We believe that these allocations can allow for enhanced performance, added diversification and improved yield potential.
More specifically, guidelines for WINC include an effective duration3 limit of three years or less, and up to a 15% weighting to both high-yield and securitized bonds. And while the fund can have foreign domiciled holdings, 100% of its exposure is in U.S.-dollar-denominated securities.
How do you approach the management of this new active ETF?
The fund takes an “all weather” approach to current income, using proactive as well as defensive strategies to target both value and income opportunities.
The ability to look beyond core holdings to expand the opportunity set can allow us to potentially enhance performance throughout different market cycles. We can actively manage duration, sector and security selection—providing greater flexibility to respond to dynamic market conditions. This diversification can also help us defensively position the portfolio and mitigate concentration risks.
WINC leverages Western Asset’s global investment capabilities and strong risk management program, employing an active process that is both top-down and bottom-up to help identify attractive credit and income opportunities while actively managing risk. While always opportunistic, we are dedicated to providing investors a long-term fundamental value discipline.
What differentiates Western Asset Management among asset managers offering active ETFs?
Western Asset is singularly focused on fixed income. Founded in 1971, our firm has decades of experience and uses a team-based approach to navigate fixed-income markets. The firm is globally integrated, with offices on five continents providing key insights to shape portfolio decisions. Additionally, we are strictly an active manager, seeking to create excess returns relative to a benchmark through very active strategies directed by highly experienced managers.
What has defined us historically is resilience—we have managed through many market cycles. Broadly speaking, we employ a valuation approach to managing our investment strategies, using both macro and bottom-up points of view to systematically identify the differences between our opinions and the market consensus. We then use the risk budget to represent those differences in a portfolio while working within strategy guidelines. Additionally, we believe in diversification, which can mean different things at different times, but is a core tenet of our investment process.
What unknowns color your outlook for global bond markets? Where do we go from here?
There are several macro events that need to be taken into consideration when investing in credit markets this year. Among these potential dark clouds are the following unknowns: 1) Will the Fed make a policy error? ; 2) Will the China-U.S. trade conflict find a positive resolution?; 3) China’s economy is slowing, but just how much?; 4) Will the U.K.-EU divorce end in a “hard Brexit”? ; 5) Can the U.S. expansion cycle hold up in spite of a global slowdown?
Despite these concerns, market technicals and fundamentals remain positive. Default rates are below historical averages and are forecasted by many to remain so, at least in the near term. As 2019 unfolds, we expect volatility to remain elevated and market liquidity to be constrained. However, as long-term active investors, we believe this creates opportunities, and our team is poised to take advantage of them for our clients.
1 Credit Quality is a measure of a bond issuer’s ability to repay interest and principal in a timely manner.
2 Yield Curve is the graphical depiction of the relationship between the yield on bonds of the same credit quality but different maturities.
3 Effective Duration is a duration calculation for bonds with embedded options. Effective duration takes into account that expected cash flows will fluctuate as interest rates change. Duration measures the sensitivity of price (the value of principal) of a fixed-income investment to a change in interest rates. The higher the duration number, the more sensitive a fixed-income investment will be to interest rate changes.
What should I know before investing?
The fund is newly organized, with a limited history of operations. Fixed-income securities involve interest rate, credit, inflation and reinvestment risks, and possible loss of principal. As interest rates rise, the value of fixed-income securities falls. High-yield securities include greater price volatility, illiquidity and possibility of default. International investments are subject to special risks, including currency fluctuations, social, economic and political uncertainties, which could increase volatility. These risks are magnified in emerging markets. Derivatives, such as options and futures, can be illiquid, may disproportionately increase losses, and have a potentially large impact on fund performance. The use of leverage may increase volatility and possibility of loss.
Potential active and frequent trading may result in higher transaction costs and increased investor liability. Asset-backed, mortgage-backed or mortgage-related securities are subject to prepayment and extension risks. Active management and diversification do not ensure gains or protect against market declines.
Any information, statement or opinion set forth herein is general in nature, is not directed to or based on the financial situation or needs of any particular investor, and does not constitute, and should not be construed as, investment advice, forecast of future events, a guarantee of future results, or a recommendation with respect to any particular security or investment strategy or type of retirement account. Investors seeking financial advice regarding the appropriateness of investing in any securities or investment strategies should consult their financial professional.
If you are neither a resident nor a citizen of the United States or if you are a non-U.S. entity, a fund’s ordinary income dividends (which include distributions of net short-term capital gains) will generally be subject to a 30% U.S. federal withholding tax, unless a lower treaty rate applies. For further information, please see each fund’s prospectus, which is available on the website www.leggmason.com. Redemption payments will be affected within the specified number of calendar days following the date on which a request for redemption in proper form is made. For more information, please see the ETF’s statement of additional information (SAI) which can be found on www.leggmason.com.
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