2023 was a year of twists and turns for fixed income, although it ended with a big rally in the final months of the year. In 2024, Schwab Fixed Income strategist Collin Martin forecasts positive returns for the asset class and believes that yields have already peaked. Additionally, he notes that bonds are once again a diversifier against equities after an ‘anomalous’ 2022, especially at current yields.
Despite believing that yields have peaked, he remains bullish on the asset class, noting attractive opportunities to generate substantial income. However, investors will need to be selective in terms of duration and quality. Martin recommends longer-duration securities to take advantage of higher yields even if yields are currently higher in CDs, bank deposits, or Treasury bills. This is because longer-term yields at 4% are quite attractive, and it negates interest rate risk in the event of Fed rate cuts.
Martin added that investors should prioritize quality especially since there is no additional compensation for taking on risk in lower-rated or high-yield debt given current spreads. Therefore, stick to Treasuries or high-quality corporate debt which offer generous yields with minimal risk. Both would also outperform in the event that economic conditions further deteriorate.
Finsum: Schwab is bullish on fixed income in 2024 although it believes that investors need to be selective in terms of quality and duration.
Separately managed accounts (SMAs) have been utilized for decades to effectively manage client assets. Benefits include transparency, flexibility, control over costs, and choice. They can be optimized for various purposes including taxes, income, cash flow, etc. They also allow for more customization than ETFs or mutual funds.
They are particularly popular for fixed income purposes and have seen impressive growth in recent years. For instance, municipal fixed-income assets went from $100 billion in 2008 to $718 billion in July 2023. In part, this is due to SMAs becoming more accessible to a wider universe of investors as improved technology has led to lower costs and lower minimum amounts to invest.
ETF’s presence in the municipal bond market is also growing fast. There are now 81 funds and $108 billion in assets, a 50% increase from 2021 but less than 3% of the total muni market. Many active mutual funds are being converted into active ETFs. One advantage is greater liquidity which allows investors to quickly gain exposure as a placeholder while they accumulate individual securities.
Mutual fund flows can be affected by market sentiment, leading to selling during periods of redemption, which is not an issue with SMAs. Due to the growth of SMAs and ETFs, muni mutual funds have seen net outflows over the last couple of years. Another factor is high rates making short-term securities or bank deposits more attractive relative to longer-duration assets.
Finsum: There are multiple ways to invest in municipal bonds. One of the fastest-growing methods is through separately managed accounts which offer some specific benefits relative to ETFs or mutual funds.
Franklin Templeton is optimistic about fixed income in the coming year due to the Federal Reserve ending its hiking cycle, and inflation continuing to trend lower. However, it believes that rates will remain at these levels for much of 2024 in order for inflation to fall to the Fed’s desired level, leading to a more challenging environment in the first-half of the year.
Amid this backdrop, the firm is bullish on municipal bonds especially with so many investors on the sidelines, overweight cash, or in short-term credit. Municipal bonds offer historically attractive yields, favorable tax treatment, and a longer-duration which should outperform in an environment with falling rates and a flattening yield curve.
The firm notes that local governments remain in strong shape from a fiscal perspective even despite a slowdown in economic activity and rising costs. Many still have excess funds leftover from federal aid during the pandemic and have been relatively disciplined in terms of spending. Further, muni bonds have lower default rates than corporate credit while also having higher after-tax returns. Franklin Templeton believes many investors will reallocate from money markets into municipal bonds in order to lock in yields at these levels especially as monetary policy eases.
Finsum: Franklin Templeton is bullish on fixed income in the coming year. It also highlights a bullish case for municipal bonds due to the sector’s strong fundamentals and favorable positioning in this macro environment.
Passive ETFs have lower expense ratios because they don't require a team of portfolio managers to constantly analyze and adjust the mix of underlying investments. Over time, this lower cost can add a meaningful amount to the value of an investor's holdings.
While advisors and investors appreciate lower expense ratios, ETF's benefits extend beyond a simple fee advantage. A closer look reveals another hidden strength: real-time trading.
Unlike traditional mutual funds, which price investments only at day's end, ETFs operate like stocks, providing continuous price transparency and allowing for immediate execution. Gone are the days of uncertainty surrounding redemption values; with ETFs, you see the precise price you'll pay and receive, empowering informed decisions throughout the trading day.
Yet another impactful advantage lies in their liquidity. Popular ETFs often boast trading volumes exceeding even blue-chip stocks. This translates to tight bid-ask spreads, minimizing the price difference between buying and selling, and enabling efficient trade execution.
The combination of low-cost, real-time pricing, and ample liquidity make ETFs powerful tools for financial advisors seeking precision and flexibility within their client's portfolios.
Finsum: Low cost is not the only reason financial advisors should consider ETFs in their client’s portfolios. Consider these other advantages as well.
Stocks whose prices trail their implied intrinsic value are often seen as attractive investments primarily due to their undervaluation. But a recent article by Vanguard suggests another reason value stocks may be worth considering now. Historically, value stocks have outperformed their “growth” counterparts in times of economic recovery.
The report quotes Kevin DiCiurcio, CFA, head of the Vanguard Capital Markets Model® research team, as he makes the case. “So, if you believe that the Federal Reserve may have engineered a soft landing—that we’re going to sidestep a recession and that the economy’s next move is an acceleration—the case for value is strengthened.”
According to their research published in August, 2023, Vanguard estimated that value stocks were priced more than 51% below their fair value prediction. They stated, “It’s well-known... that asset prices can stray meaningfully from perceived fair values for extended periods. However, as we explained in (previous research), deviations from fair value and future relative returns share an inverse and statistically significant relationship over five- and 10-year periods.”
This observation adds one more reason value stocks are worth a look. In addition to favorable valuations and historically consistent dividends, the possibility that value stocks may shine during the coming economic recovery many anticipate, is another factor to consider. Whether held directly, within a passive allocation, or as part of a Separately Managed Account, now is a perfect time to revisit the case for value stocks in your client’s portfolios.
Finsum: Vanguard's research highlights value stock historical outperformance during economic recoveries.
If you’re tinkering with the idea of bonds, consider this: the challenges on the fixed income landscape, according to money.usnews.com. For those who aren’t initiated, individual bonds – which trade over the counter – it can be a tough road to hoe.
That’s where bonds funds come in. For investors, they’re an entrée to diversified bonds. And what about the complexities of direct bond investment? There are none.
"Given the higher risks and costs associated with portfolios of individual bonds, and the time they take to manage, most investors are better served by low-cost mutual funds and exchange-traded funds, or ETFs," said Chris Tidmore, senior manager at Vanguard's Investment Advisory Research Center. "This is particularly true in the case of municipal and corporate bonds, which are less liquid and harder to purchase than Treasury bonds."
Meantime, calling it a day was Eric Needleman, global head of Fixed Income, who plans to do so by year’s end, according to an announcement by Stifel Financial Corp., reported yahoo.com.
"We are deeply grateful for Eric’s dedication, leadership, and the lasting impact he has made on our firm,” said Stifel Chairman and CEO Ron Kruszewski. “He set a standard of excellence that will continue to define Stifel's approach to the fixed income business.”
Risk adverse?
Well, perhaps you’ve pulled up to the right window. After all, a big upside of active fixed income management: risk mitigation, according to npifund-com.
Possible problems – before they damage client portfolios – can be traded out of by alert active fixed income managers. What’s more, the site states: “We believe the next problem to address with active management is the leverage bubble in corporate debt. The disproportionately large BBB market, in particular, “poses a risk to the markets in the event of a wave of downgrades under the right recessionary scenario.”
Meantime, it seems investment strategy and fixed income teams at Vanguard have been burning a little midnight oil.
According to corpaemdisp.essp.c1.vanguard.com, new research from the company’s teams taken a close look into how the growth of a diverse coupon stack in the municipal bond market, followed by, down the line, “aggressive Fed rate hikes put negative convexity front and center in active muni investing.”
Those active managers steering through this environment of souped up rates are gaining leverage. Why? Because they’ve been able to wrap their heads around how to manage negative convexity risk – and they’ve been prudent while they’re at it.
Share and share alike?
Well, tell that to exchange traded funds. While they burgeoned in popularity, when it comes to sharing equally – or consistently – in the billions of dollars investors pluck down on them monthly, they don’t exactly participate, according to thinkadvisor.com.
An ETF focused on environmental, social and governance investing was one that trailed the pack. Year to date, it experienced the largest withdrawals. “(That suggests) that there may be some backlash against ESG from investors,” said Sumit Roy, senior ETF analyst at ETF.com.
In any event, as an investor, want a cost effective way to diversify your portfolios across various asset classes: you’ll get that from top ETFs, according to Investopedia.com. The work of ETFs, it seems, is never done. Not only does it track a particular index, sector or commodity and trade on a stock exchange, the way in which it goes about it mirrors that of a regular stock, putting investors in a position to wield greater flexibility.
Stress in the bank sector? Sure, okay.
Uncertainty spawned by the U.S debt ceiling? Yep, no one can legitimately propose an argument to the contrary.
Political uncertainly festering in Russia? Well, yeah, if you’ve watched even a scintilla of news lately.
Despite that exhaustive list, the global economy’s hanging tough, strutting its resilience, according to gsam.com, which believes a restored allocation to core fixed income can help boost the ability to reinforce the resilience off portfolios to periods of bearish sentiments. That’s especially in light of a bounce in yields which have bolstered the protective power and income benefits of high quality bonds.
Meantime, the economy continues to perform better than expected, seemingly shucking aside rates hikes that have been a mainstay since last March, according to privatewealth-insights-bmo.com.
Consumers, buoyed by high employment, not to mention escalating wages, have hung tough.
For this cycle, with Canadian rates riding high and the stream of rate hikes -- for the most part, at least -a thing of the past, the time to take another look at fixed income allocations is right.
In one corner of the investment world: the traditionalists; in the other, the alternatives.
A survey of 191 investment professionals from February 14, 2023 to April 7of this year showed a mounting interest in alternative investments among professionals, at 28%, predating the pandemic, according to thestreet.com.
"As traditional stock and bond asset classes suffered from losses and volatility in 2022, it's not surprising that interest in alternative investments increased among financial professionals. However, overall use of alternatives remains relatively low,” 2023 FPA President James Lee, CFP, CRPC, AIF, said in a press release.
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While alternative investments are catching the attention of some financial advisers, the survey highlighted that over 90 percent of investment professionals currently use or recommend exchange-traded funds (ETFs).
Unlike traditional assets, of course, alternative investments aren’t subject to US Securities and Exchange Commission regulatory requirements, according to coresignal.com. That’s significant since it translates in further room for speculative investment practices.
There’s a scant link between alternative assets and the stock market – not to mention other conventional investments, according to coresignal.com. Consequently, they’re not required to react to market conditions as they shift. For conventional securities, it’s a different story.
Alternative investments, fueled by high fees and minimums, typically are accessible to institutional investors exclusively.
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It seems there’s not much, um, fixed, about fixed income. That’s because, pre tell, in the second half of the year, conditions there likely will be choppy, according to dayhagan.com.
Ongoing tightening by central banks in the developed markets is pushing up short term yields, while long term yields are feeling the weight of slower growth and a pull back in inflation seemingly on the horizon later this year.
Meantime, the fixed income allocation strategy experienced scant changes in sector allocations coming into the month.
Now, want to talk about a calorie burner? Presenting active, active and more of it.
As in, as if you had to ask, active management.
"Everywhere we turn, we are hearing that a new dawn is upon us, and it is once again the time for active management. Many would be surprised that I totally agree, said Jason Xavier, head of EMEA ETF Capital Markets at Franklin Templeton, according to global.beyondbullsandbears.com.
It could be argued – as outlined in his predictions for the year – that the decade of “cheap” money and unprecedented low interest rates are a thing of the past and that those with the chops to work the volatile markets will reap the benefits.
That said, the picture on the horizon boasts considerably more potential; in other words, the dawn of active fixed income in the exchange traded fund or ETF vehicle. Clinging to the assumption that ETFs are a passive vehicle – and passive vehicles only – is a myth, he continued.
Volatility’s not your game? You’re sure now?
Well then, to tamp down volatility in a portfolio – or generate steady income -- fixed income assets are popular alternatives to dividend stocks, according to money-usnews.com. And the assets pay out a defined stream of income.
It typically assumes the form of bonds, which, essentially, are IOUs investors can reach into their wallet for from a number of sources, like, for example, governments and corporations.
That said, bond investing isn’t as easy as one-two-….you get the ides. Instead, since individual bonds are traded over the counter and mucho calculation is required to price correctly, it can be complex.
"Given the higher risks and costs associated with portfolios of individual bonds, and the time they take to manage, most investors are better served by low-cost mutual funds and exchange-traded funds, or ETFs," said Chris Tidmore, senior manager at Vanguard's Investment Advisory Research Center in Wayne, Pennsylvania. "This is particularly true in the case of municipal and corporate bonds, which are less liquid and harder to purchase than Treasury bonds."
Meantime, this for U.S. investors in exchange traded funds: you might want to mull over taking the splash into medium-term fixed income ETFs. according to marketwatch.com. Why, you might ask? They could not only dispense “attractive carry,” they also could translate into a “buffer” against the volatile returns in the U.S. equity market. That’s in light of the fact that the Fed’s path toward interest rate hiking’s immersed in a lack of clarity, Gargi Chaudhuri, BlackRock’s head of iShares investment strategy for the Americas, said.
Going….going…..gone.
Nope; no precious four baggers here. Instead, ESG recently took something of a hit as the United Nations convened a climate alliance for insurers, according to reuters.com. A minimum of three additional departures – including the chair of the group – took place. What had them heading for the exits? Opposition from U.S. Republicans pols.
As of the time of this report, on May 25, that meant at least seven members of the Net-Zero Insurance Alliance had bid the group adieu, with five of the eight founding signatories included. NZIA was founded in 2021.
Over the past year, in terms of reaching decisions evolving around investments, negativity stemming from the contemplation of EGS factors has dominated the landscape, according to weforum.org.
The invasion of Ukraine, inflation and, in some parts of the world, a spike in populism, have aroused criticism surrounding ESG.
The caveat: integral to abetting the swing to a greener, more sustainable future hinges on investing that’s truly sustainable and, consequently, shouldn’t be shucked aside.
Even so, the period of negative scrutiny in so much as arriving at investment decisions generated by ESG factors, has been unprecedented.
In an article for Benzinga, Piero Cingari discussed the bear market in office REIT stocks as the vast majority are now trading at their all-time lows. It’s not entirely surprising given that workers are not returning to the office, following the pandemic, despite the best efforts of many employers.
As a result, many companies are giving up office space and/or choosing to move to a hybrid model. Of course, this has spillover effects on other areas such as the businesses that sell products and services to these workers.
In the first week of May, office occupancy in the 10 largest US cities was at half the levels that were seen prior to the pandemic. Many analysts had predicted that office occupancy would gradually ‘normalize’ just like so many other parts of the economy have done so. Yet, this isn’t the case and occupancy hasn’t risen over the last 6 months which is an indication that the changes may be permanent.
Adding to the sectors’ woes is higher rates leading to higher borrowing costs, heavy levels of short interest, and rising crime rates in many urban areas.
Finsum: Office REITs have been crushed amid high rates and corporations reducing office space with occupancy at 50% of pre-pandemic levels.