Clark: Move Between Bond Duration

December 12, 2013

Rates are likely to head higher, but the sky isn’t falling.

This article is part of a regular series of thought-leadership pieces from some of the more-influential ETF strategists in the money management industry. Today's article features K. Sean Clark, CFA, chief investment officer of Philadelphia-based Clark Capital Management.

The Federal Reserve’s comments and actions this year have resulted in wild swings in the fixed-income markets. But before those comments, as of April 2013, investors continued to pile money into bonds despite record-low interest rates and the S&P being up more than 157 percent since the 2009 lows.

However, following Ben Bernanke’s comments on May 21, insinuating that the Fed might start to taper its bond-buying “quantitative easing” program, global fixed-income markets came under intense selling pressure. Fixed-income investors exited all kinds of bonds, and the price action was deemed a “taper tantrum” by the financial media.

The first half of 2013 became the worst six-month period for bonds since 1994—a year that was marked by four Fed rate hikes before June 30.

Chatter about the impending bursting of the bond bubble has reached a crescendo this year, and dramatic volatility in the fixed-income markets apparently helped fuel talk of a “great rotation” out of fixed income and into equities.

However, for many investors, abandoning fixed income simply may not appear to be a desirable option. For these investors, the high-yield fixed-income sector may help mitigate some of their exposure to interest-rate risk.

And, to the extent that a rise in rates isn’t likely, in our view, to come all at once, we think rotating between Treasury ETFs like the iShares Barclays 7-10 Year Treasury Index ETF (IEF | A-50) and the iShares Barclays 20+ Year Treasury Index (TLT | A-72), and junk bond ETFs such as the iShares iBoxx $ High Yield Corporate Bond ETF (HYG | B-72) and the Barclays High Yield Bond SPDR (JNK | B-68), makes a lot of sense.

But first, let’s review a bit of bond yield history.

The charts below offer a historical perspective on the effects of a modest rise in interest rates on high-quality bonds. Each of the six time periods reflects the performance of fixed-income sectors over the past 30 years when the 10-year Treasury yield rose by more than 1 percent (source: Morningstar Direct).

Rising_Bond_Yields_Historical_Comparison

In each of the cases above, the high-yield bond performance was positive, while Treasurys’ performance across the yield curve was negative.

This year has given fixed-income investors more heartburn, as rising interest rates appear to be responsible for muted returns. Did the historical precedents of negative Treasury performance and positive and relatively strong high-yield performance hold true once again?

 

 

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