Natixis: Hanging Tight Around The 2-Year Curve

October 28, 2019

[This ETF industry perspective is sponsored by Natixis Investment Managers.]

Chris Harms

Christopher Harms, co-head of Loomis, Sayles & Company’s Relative Return team and co-manager of the Natixis Loomis Sayles Short Duration Income ETF (LSST), shares his market insight, outlook on risk, and insight as to why actively pursuing opportunities in and around the two-year yield curve makes a difference.

ETF.com: What should investors expect from the bond market in 2020?
Harms: Investors should be prepared for continued volatility for at least the next 12–18 months in light of ongoing geopolitical issues and trade negotiations, not to mention the U.S. presidential election next year.

The volatility pattern we've seen in the market recently—rally, sell-off and rally again—will most likely stick around for a while.

In the range of a few months, we experienced the two-year Treasury going from 1.45% to 1.80%, and then back to 1.47%. That type of volatility is unprecedented in that part of the yield curve, especially in the absence of a major market crisis. I think Fed policy, and market confidence that interest rates would stay put, were the primary contributors to this abnormal pattern.

How do Fed cuts or hikes influence your portfolio construction?
The investment process that underlines the Natixis Loomis Sayles Short Duration Income ETF (LSST) isn’t influenced by an interest rate outlook or Fed action. We believe our advantage is in actively allocating between sectors and investing in fundamentally attractive securities rather than making major yield curve and interest rate calls.

We think staying near the two-year average helps us minimize interest rate risk over time, as well as deliver some price appreciation that shorter-term-focused strategies—such as ultra-short funds/ETFs or money markets—may not be able to produce.

Should U.S. investors be concerned about the negative rates occurring in foreign markets?
Absolutely. It’s something we keep an eye on every day. Negative rates are impacting flows as foreign investors are finding U.S. markets much more attractive. But there are currency and hedging costs to consider, especially as the U.S. dollar strengthens. As hedging costs increase, investors will likely pull out of U.S. markets. This is one of the reasons we are currently at the lower end of our risk budget in sector-spread-type products such as U.S. corporate investment grade and high yield bonds.

Would you talk a little more about your risk budget?
We increase our risk budget when spreads widen, and decrease the budget when spreads tighten, which we’ve done recently. Spreads on U.S. corporate bonds started the year at around 1.5% wider than Treasurys, on average. They have come in as tight as less than 1%, and traded about 80–90 basis points off and then widened back out to 1.25%.

This is one example of why active management can make a difference versus indexing. Active management allows portfolio managers to overweight and underweight specific allocations. We want to own securities that we believe—on a risk-adjusted basis—offer value. LSST seeks to offer investors a high quality, liquid solution with active duration management. We allocate across various sectors that are in our investment toolbox: high quality instruments such as U.S. government agencies, investment-grade corporate bonds, commercial mortgage-backed securities and asset-backed securities.

How much do you incorporate Loomis Sayles’ global research infrastructure into LSST?
It is our fundamental belief that markets misprice risk and overreact to short-term news, events, and supply and demand factors. Therefore, combining top-down macroeconomic analysis with bottom-up security selection, with the support of Loomis Sayles’ various research teams, is a real differentiator for us.

Loomis Sayles is a research-intensive firm, and we draw on our deep credit, government and agency research resources to understand every security we put into the portfolio. This is combined with top-down analysis provided by our Macro Strategies team, which assists us in managing interest rate risk.

We also look across sectors to find attractive opportunities. Our trading desk also adds significant input on the valuation of each security. All of this information flows into the Short Duration team to make the ultimate allocation decisions for LSST.

Could you provide an example of this selection process?
Let’s take, for example, a new corporate bond issued in the marketplace from XYZ Corp. It has a three-, five-, 10- and 30-year bond for a total of $3 billion outstanding.

First, a research analyst analyzes the bonds to determine if the market and the rating agency evaluations of the credit differ from Loomis Sayles’ proprietary research evaluation, and why, and assigns an internal credit rating to the bond.

Next, trading weighs in on where the existing bonds are trading, and where on the yield curve—three-year, five-year, etc.—might be the most attractive option.

Then, using all of the provided research and data, the LSST portfolio management selects the issues with the best value potential for the portfolio.

Why should investors consider LSST today?
I think most investors need a short-term bond component in their portfolios. They need a short-term debt type of return profile to meet their near-term financial needs. LSST seeks to offer this to investors through its high quality, highly diversified allocation that also features interest rate exposure management.

Past performance is no guarantee of future results.

About Risk:
The fund is new, with a limited operating history. Exchange-traded funds (ETFs) trade like stocks, are subject to investment risk and will fluctuate in market value. Unlike mutual funds, ETF shares are not individually redeemable directly with the fund, and are bought and sold at market price, which may be higher or lower than the ETF’s net asset value (NAV). Transactions in shares of ETFs will result in brokerage commissions, which will reduce returns. Unlike typical ETFs, there are no indexes that the fund attempts to track or replicate. Thus, the ability of the fund to achieve its objectives will depend on the effectiveness of the portfolio manager. There is no assurance that the investment process will consistently lead to successful investing. Fixed income securities may carry one or more of the following risks: credit, interest rate (as interest rates rise, bond prices usually fall), inflation and liquidity. Below-investment-grade fixed income securities may be subject to greater risks (including the risk of default) than other fixed income securities. Foreign and emerging market securities may be subject to greater political, economic, environmental, credit, currency and information risks. Foreign securities may be subject to higher volatility than U.S. securities, due to varying degrees of regulation and limited liquidity. These risks are magnified in emerging markets. Interest rate risk is a major risk to all bondholders. As rates rise, existing bonds that offer a lower rate of return decline in value because newly issued bonds that pay higher rates are more attractive to investors.

“Investment grade” refers to bonds rated BBB/Baa or higher. Ratings are determined by third-party rating agencies such as Standard & Poor’s or Moody’s and are an indication of a bond’s credit quality.

Outlook as presented in this material reflects subjective judgments and assumptions of the portfolio team and does not necessarily reflect the views of Loomis, Sayles & Company, L.P. There is no assurance that developments will transpire as stated. Opinions expressed will evolve as future events unfold.

Before investing, consider the fund’s investment objectives, risks, charges and expenses. Please visit www.loomissayles.com or call 800-458-7452 for a prospectus and a summary prospectus, if available, containing this and other information. Read it carefully.

ALPS Distributors, Inc. is the distributor for the Natixis Loomis Sayles Short Duration Income ETF. Natixis Distribution, L.P. is a marketing agent. ALPS Distributors, Inc. is not affiliated with Natixis Distribution, L.P. Natixis Distribution, L.P. (fund distributor, member FINRA|SIPC) and Loomis, Sayles & Company, L.P. are affiliated.

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