The latest data release from BlackRock’s iShares division revealed troubling news about the state of Bond Market ETFs: inflows slumped to just $14 billion which is the lowest since the onset of the pandemic. It's the taxable corporate bond market that's fairing the worst as investors are pouring less dollars into traditional corporate debt and junk bonds, amid fears of inflation eating yields. Instead, investors are turning to shorter duration and inflation protected bonds. Nearly 40% of fixed income flows went into inflation linked bonds, an almost unprecedented number. Investors have also started to put inflows into Chinese bonds as the international sovereign debt market was a relative winner among bond ETFs. China’s yield is the biggest draw to international investors as they see the debt as relatively secure and paying more than developed countries.
FINSUM: Expect corporate bond outflows to continue until the TIPS spread starts turning towards the Feds 2% inflation objective.
Over 500 institutional investors were surveyed and one of the top 5 most important themes going into 2022 is active management in areas like fixed income markets. A combination of factors are leading to more investment but broadly speaking, it is uncertainty which is having investors leaning into active management. On top of this, active management is preferred as the best strategy in risk management overall. A majority of those surveyed believe high fluctuation in inflows and outflows to passive funds put the market in a more systemically risky position. Despite a dragging start to 2021, 70% of investors said their active funds outperformed passive ones.
FINSUM: Picking stocks is always hard, but increased volatility could give pickers an edge.
Jerome Powell and the Fed turned a 180 this week with the future of its asset tapering and interest rate hikes. The Fed sees Covid and omicron as yesterday's demons and have set their sights on inflation. With that the Fed is gearing up for potentially three rate hikes in 2022 and is moving away from the transitory inflation story. This could be bad for bond investors as the Fed’s tune could change if omicron picks up or inflation shifts gears, meaning there is a lot of uncertainty about future rates. Nonetheless, higher rates could undercut existing long term bonds so those still invested in bonds should consider switching their investments to shorter duration Fixed Income ETFs or less sensitive corporate bonds. Lower duration bond ETFs will be more stable when there is interest rate uncertainty (unlike in standard times).
FINSUM: The Fed could just as quickly hop off the inflation fighting hawk train if they get a series of lower PCE reports, which means investors need to be ready for various scenarios.
Saying the bond market is difficult would be more than an understatement, and while yields are creeping it's still hard to get the historic performance. However, many investors are turning to active fixed income ETFs. This has led to a swelling of inflows into the market category making up 16% of ETF inflows in 2021 through October. Turmoil at the Fed and the continual threat of a taper tantrum have many investors looking to pros to sort out the difficulties in the bond market. Active FI ETFs can also fit narrower targets and accommodate the rapidly shifting macroeconomic environment.
FINSUM: Seasoned veterans at the helm make the most sense when the environment is shifting, and active ETF can edge out when the future is uncertain.
The low yields in the bond market have made it relatively uninteresting to the average investor, but there is a revolution underway. The bond market has been dominated by traditional techniques and old school investors, but many of the quants and hedge funds that overturned the equity market are eyeing the bond market. Systematic corporate bond investing is expanding and firms are taking advantage of trends in government debt or pricing anomalies in bond derivatives. Driving this trend in the bond market is swaths of data that are a part of how trades are now realized. Companies like Blackstone Credit are prepared for the shift into a more systematic trading environment in bonds, and other companies are ramping up their tools to accommodate this shift. FINSUM: Hard to acquire data, and a less liquid market have made bonds less desirable for quants, but the information age is rapidly changing that standard.
The bond market boon has been bad for many fixed income investors, and debt is coming to term in a higher inflationary environment which is eating up all the return. However, bond market investors are turning to factor based investing to earn excess returns. Factor investing is a $700 billion market in equities, and it dwarfs the $25 billion dollar fixed income factor market. Factor investor modifies indices based on factors they think can give an edge over traditional indices. Active bond factor investing can outperform traditional indices in rising yield environments, but factor investing is looking to rival these active funds with systemic decisions. A ‘smart beta’ approach will look to outperform in high yield and emerging market debt.
FINSUM: The extensive literature on systemic fixed income is relatively small, and that's why smart beta strategies have failed to take off in the bond market like they have in equities.
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Dalio is quick to remind everyone to avoid holding cash as inflation eats away at holdings, but he also recently provided stocks for investors looking to hedge. The first on the list is Global Payments which has sound fundamentals and sequential quarterly revenue gains and is a bright spot in a growing industry. The next was Levi Strauss and Company which shrugged off naysayers who believed supply constraints and bottlenecks would keep them from meeting demand. Finally, was Lithia Motors which is a large automotive group. Supply constraints have boosted used car prices and the industry’s bottom lines.
FINSUM: These are all unique picks that have their built in inflation benefits, particularly the automotive industry.
Throughout 2021 one of the biggest worries for investors, business owners, and policy makers has been the return of inflation…see the full story on our partner’s site
Evergrande’s crisis has been all over the news in the last month, but it appears there is contagion in the high yield debt market. The bond market sell off, particularly from off-shore investors has spread to companies like Tencent and financial companies like Bank of Communication Hong Kong. This has pushed the ICE BofA Asian Dollar High Yield Corporate China Issuers Index to over 25%, which is the peak yield for the index since 2008. Sparking the yield climb is a combination of regulation, high leverage, and low liquidity. A bump in liquidity from the Chinese central bank has calmed domestic investors, but ultimately government policy will have to lighten up for yields to start to fall.
FINSUM: The endless regulation is spilling into the rest of the economy in China, and no amount of liquidity provisions will bring back outside investors. Rather, China needs to loosen the grip if they want to give companies a chance at refinancing their debt moving forward.