5 Views On Fixed Income ETFs For 2018

March 27, 2018

Where do you see interest rates heading?

Jenkins: We do not have strong conviction on rates right now.

The 10-year Treasury yield is up over 80 bps since last September, as the market has priced in the tax cuts, increasing supply of and decreasing demand for Treasuries, and the prospects of increasing growth and inflation.

In the intermediate to long term, our expectation is that the 10-year yield will continue to move higher, but will remain low by historical standards.

In the near term, we think the recent sell-off could be overdone.

Arone: The 10-year Treasury’s failure to break through the 3% threshold leads me to conclude that interest rates are likely to remain range bound for most of 2018. U.S. economic growth may be improving but remains stubbornly below the 3% milestone.

The market may have experienced an inflation scare in February, but with the recent average hourly earnings and core CPI data releases, it’s hard to argue the economy has an inflation problem. Combine that with the structural tail winds of aging U.S. demographics, the disinflationary impacts of technology and the growth dampening effects of debt on the economy, and rates are likely to remain well anchored.

Schneider: Six months ago, we believed interest rates were mispriced when the two-year Treasury note hovered around 1.25%. Now with the yield near 2.3%, we are closer to fair value. With a flatter yield and credit curves, the question for investors is, should they reach for additional duration (interest-rate exposure) or equity dividends, which are around 2%, to produce attractive returns?

Probably not. The sector has gone from an afterthought of cash management to a structural allocation for those fearful of volatility or higher rates in 2019 and beyond. Our view is that investors should consider being positioned to embrace higher rates in the U.S. during this course of time.

Flanagan: The bond market is beginning to think the Fed may raise rates more than the Fed projected. Three moves have been fully priced in the Fed funds futures market, and the conversation has turned to the possibility of a fourth tightening move in 2018 (one rate hike each quarter).

Barring any unforeseen events (e.g., geopolitical), it also appears likely the U.S. 10-year yield has moved into an elevated trading range, with the 3% threshold representing a key technical level.

Are there any areas of the fixed-income market where you see value or that you would avoid (including any specific ETFs)?

Jenkins: When we look at our portfolios, it’s easy to find exposures we’d like to trim. The problem is where to go. Yields remain low by historical standards, and despite recent volatility, credit spreads are very tight.

We’ve gradually been improving the quality of our portfolios. We’re big believers of active ETFs, and like some of the broad names, including the First Trust TCW Opportunistic Fixed Income ETF (FIXD), the SPDR DoubleLine Total Return Tactical ETF (TOTL), the Fidelity Total Bond ETF (FBND) and the PIMCO Active Bond ETF (BOND).

As the Fed continues its path of tightening, cash is becoming a real asset class again. We like some of the active names in the ultrashort bond space, including MINT, VNLA and VRIG. We also like the floating-rate structure of bank loans, including BKLN and SRLN.

Arone: The SPDR Bloomberg Barclays Investment Grade Floating Rate ETF (FLRN) is a compelling value. It seeks to track an index of short-term investment-grade floating-rate notes with coupons that adjust based on movements in short-term rates such as LIBOR.

As demand increases for short-duration solutions, investors may want to consider floating rate structures over fixed-coupon bonds. The majority of these securities are tied to the three-month London interbank offered rate (LIBOR) plus a predetermined spread.

The benefit of this structure is most pronounced as interest rates rise, because it reduces interest rate risk relative to fixed-rate bonds. LIBOR has increased by 95% since the start of 2017, and is at its highest level since late 2008.

As a result, the floating-rate index has outperformed its fixed-rate counterpart over the past year and year-to-date. With short-term interest rates poised to move higher, the outperformance of floating-rate notes may persist.

Flanagan: Many areas within the fixed-income universe appear to be fully valued. Credit spreads have narrowed to multiyear lows, and some market corrections should not be ruled out, but we feel that investment grade and high yield corporates could remain in a range-bound pattern. That being said, it will likely be difficult to replicate recent years’ performances.

Emerging market local debt has been the best performer in fixed income this year and continues to offer some moderate value from a “carry” perspective.

Smith: We are generally cautious, with durations a bit short versus the market, and we have reduced our allocations to U.S. high-yield debt.

We still have some exposure to the following areas: emerging market debt [iShares JP Morgan USD Emerging Markets Bond ETF (EMB)]; preferreds [iShares U.S. Preferred Stock ETF (PFF)]; senior bank loans [SPDR Blackstone / GSO Senior Loan ETF (SRLN)] and inflation-protected securities [iShares TIPS Bond ETF (TIP)].

We preferred these allocations because we believe rates are gradually headed higher under the influence of Fed monetary policy efforts, the yield curve will continue to be biased toward flattening, and economic activity will remain buoyant and positive, thus putting more pressure on inflation indicators.

Follow Sumit Roy on Twitter @sumitroy2

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