On fixed income, you need to be incredibly selective. Bonds were a tremendous asset class to own in the ’70s, ’80s and ’90s. If you bought the aggregate bond index, you got income, diversification, hedging and carry. Unfortunately, after a 30-year bull market—and particularly in the last seven, eight years when you've had $2 trillion of inflows into bonds—all the historical attributes are gone.
We're cautiously using parts of fixed income only for income. We own preferreds and senior loans in the iShares U.S. Preferred Stock ETF (PFF) and the SPDR Blackstone / GSO Senior Loan ETF (SRLN). And we're using the iShares JP Morgan USD Emerging Markets Bond ETF (EMB) to play the bullish EM story and for some elements of carry.
ETF.com: What ETFs are you using for other attributes of fixed income, like diversification, protection and hedging?
Davi: The IQ Hedge Multi-Strategy Tracker ETF (QAI) is a good liquid alternative. The benefit of QAI is that it manages the downside in a liquid, systematic and rules-based framework. If you look at the 10 worst months with the S&P 500 since 2008, the underlying index for QAI was down about 18%, and the S&P was down, collectively, 57%. That's the downside-capture ratio a hedge fund historically would have given you. So you get the benefit of managing the downside for a very attractive cost.
To further hedge our portfolio risk, we’re using gold—the iShares Gold Trust (IAU)—as well as the iShares 20+ Year Treasury Bond ETF (TLT) and the PIMCO 25+ Year Zero Coupon US Treasury Index ETF (ZROZ). Gold is a low-delta call option on the bitcoin bubble blowing up, or to hedge events like a North Korea bomb or even if inflation rises. Gold is uncorrelated, it carries well in the portfolio, and ownership is relatively light—especially if you compare it to cryptocurrencies.
ETF.com: If bitcoin ETFs do come to market, would you be an early adopter? What's your view on the bitcoin phenomenon?
Davi: We would not use bitcoin ETFs in our portfolio even though it's had a tremendous rally. It could go up a lot more, but we focus on asset classes that we can analyze their earnings and discount their cash flows.
ETF.com: What should investors avoid going into 2018?
Davi: You want to stay away from high-yield credit, funds like the SPDR Bloomberg Barclays High Yield Bond ETF (JNK) and the iShares iBoxx $ High Yield Corporate Bond ETF (HYG). It’s a poor risk/reward in our view.
Historically, when the Fed has tightened, credit spreads have widened, and valuations are extremely rich. It’s simply not the time of the cycle where you want to own high-yield credit. I’m worried how high-yield bonds will react if there’s a slip in the economy or if liquidity declines. Junk bonds are illiquid and sensitive to the economy. In 2008, high yield was down 25%, and there are a lot more sellers now.
ETF.com: What about commodities?
Davi: This is an out-of-consensus view, but we think it’s prudent to start to incorporate commodity-based strategies within a portfolio. Investors have excluded this asset class at large since 2008, but we think—given where we are in the cycle—they now warrant attention. They’re uncorrelated, under-owned and serve as a call option on inflation.
Contact Cinthia Murphy at [email protected]