The Federal Reserve may be on pause, but there’s no way to know with certainty what its next move will be.
Global growth is slowing now, but that may not remain the case if the U.S. and China make a trade deal.
The yield curve has flattened, but that doesn’t mean you should completely shun duration in your portfolio.
These were some of the points raised in an early-afternoon panel on fixed income at the Inside ETFs conference in Hollywood, Florida. Guided by moderator Tom Lydon, five fixed-income experts discussed a broad range of topics over 50 minutes, including advice on how investors should position their portfolios in 2019.
Is The AGG Flawed?
An area of disagreement among the panelists concerned whether the Barclays Aggregate Bond Index is flawed. William Housey, senior portfolio manager at First Trust Advisors, and Gene Tannuzzo, deputy global head of fixed income at Columbia Threadneedle Investments, argued that the AGG is indeed flawed.
“It makes up less than half of the global bond market, and the yield-versus-duration combination doesn’t seem attractive,” argued Tannuzzo, while noting that the AGG’s yield of 3% and duration of six years weren’t compelling.
Tannuzzo and Housey suggested that using active or rules-based alternatives to the AGG could result in better outcomes for investors.
On the other hand, Jason Singer, head of fixed-income ETFs at Goldman Sachs Asset Management, had a different perspective.
“I don’t think the benchmark is flawed,” he said. Rather, it’s about what end-users want.
“If you’re looking for a blunt instrument, [ETFs tied to the AGG] get that exposure at a price point,” Singer added. “To the extent people are looking to change that market risk, that’s where active management comes into play. One is about exposure, one is about exposure plus alpha. It depends what you’re looking for.”
A big concern about fixed-income ETFs has been the idea that when markets turn volatile, liquidity will dry up, leading to a breakdown in those products that hold relatively illiquid underlying securities.
But the panel argued that those concerns are overblown and that the action in December proves it. Rather than run away from those types of fixed-income ETFs in December, investors embraced them, and actually used them for liquidity.
Overall, fixed-income ETFs had inflows of more than $16 billion in December, and $15.5 billion in January, according to data from FactSet.
Outlook For 2019
When asked about the outlook for fixed income in 2019, Michael Arone, chief investment strategist at State Street Global Advisors, was circumspect.
“The Fed is likely on hold, but interest rates could be a lot more variable than we think,” he offered. He advised investors to stay defensive, while avoiding taking equity-like risk in their fixed income portfolios.
“Stay on the short end; don’t take on too much interest rate risk; and don’t take on too much credit risk in 2019,” Arone added.
Goldman’s Singer agreed on the attractiveness of short-term rates. “Cash is king,” he said. “In today’s environment, you’re getting somewhere between 2.25% and 2.75% on cash.” Therefore, “optimizing your cash is key.”
Still, he advised that owning “some level of duration and high-quality duration makes sense within a portfolio in 2019.” Singer believes credit could perform quite well this year, but investors should be mindful we’re late in the cycle.
“Have strategies and filters that could weed out underperforming issuers,” he suggested.
Meanwhile, Columbia Threadneedle’s Tannuzzo says the most important thing investors can do in 2019 is stay diversified. Cash may be attractive right now, “but If you look historically, when the yield curve is flat, the best forward returns come from long-term bonds,” he noted.
Additionally, investors should “diversify into credit sectors and global sectors,” Tannuzzo said.
The Case For High Yield
First Trust’s Housey had a somewhat more aggressive outlook for 2019 than the rest of the panel.
“The 2019 playbook is really similar to 2016. The Fed is on pause; they’re not done,” he explained. “Risk sentiment is going to be hinged on trade.”
Housey told investors to be careful with the prevailing narrative—there is a global synchronized slowdown. Based on his discussions with corporate CEOs, they are waiting to see the rules on trade before they act. Once there is a trade deal with China, it’s going to act like stimulus, as all of the capital that is being withheld comes back into the economy.
As that happens, the dollar will weaken, boosting commodities and high yield—an area he does not see as being in a bubble. Tens of billions of dollars has flowed out of high yield in recent years, evidence of a lack of euphoria in the space. On top of that, default rates are at less than 2%, making high yield compelling.
Housey added that, bank loans, which have similar yields as high yield but are higher on the capital structure, may be even more appealing based on valuation.