Displaying items by tag: credit
Investing in Corporate Credit
Two ever-present risks for fixed income investors are credit risk and interest rate risk. Rising interest and default rates diminish the value of bonds and have to be considered especially with corporate bonds.
However, some ETF issuers now offer corporate bond ETFs with less credit and interest rate risk such as the WisdomTree U.S. Short Term Corporate Bond Fund (SFIG). It currently offers a 4.76% yield and invests primarily in short-term, corporate debt with an effective duration of 2.47 years. It’s notable that SFIG can offer such generous yields despite investing in high-quality debt with over 44% of holdings rated AA or A.
Another potential catalyst for SFIG is when the Fed cut rates later this year. Currently, there are trillions on the sidelines in money market funds and some of this would migrate to funds with higher yields like SFIG.
According to BNP Paribas, another reason to be bullish on investment-grade corporate bonds is due to lower issuance and structurally, higher inflows. It sees less of a case for capital appreciation given the flat yield curve and recent rally, but it believes that yields at these levels are sufficiently attractive.
Finsum: Corporate bond investors have to be mindful of credit and interest rate risk. Investors can mitigate these factors with an ETF that invests in high-quality, short-term corporate debt.
Data-Dependent Fed Means Opportunities for Fixed Income Investors
Entering the year, there was considerable optimism that the Fed could begin cutting rates as soon as March. However, the February FOMC meeting, recent inflation data, and the January jobs report have made it clear that the status quo of a data-dependent Fed, prevails. It’s clear that the Fed’s next move is to cut, but timing is the mystery.
This state of affairs means that the window for bond investors, seeking value, remains open. While recent developments have been bearish for bonds, investors have a chance to take advantage of higher yields if they are willing to live through near-term volatility. This is especially if they believe the Fed will cut rates later this year which will lift the whole asset class higher.
According to Bloomberg, “The US economy is testing bond traders’ faith that the Federal Reserve will deliver a series of interest-rate cuts this year.” Investors can buy the dip with a broad bond fund like the Vanguard Total Bond Market Index Fund ETF, or they can search for more yield by taking on more credit risk with the Vanguard Short-Term Corporate Bond Index Fund ETF. Both have low expense ratios at 0.04% and 0.03%, respectively, and have dividend yields of 3.2%.
Finsum: Bonds are experiencing a bout of weakness due to uncertainty about the timing and extent of the Fed’s rate cuts. Here’s why investors should consider buying the dip.
Upside Case for REITs in 2024
Rich Hill, the head of Real Estate Strategy at Cohen & Steers, shared his bullish outlook for REITs in 2024. He sees falling interest rates, tightening credit spreads, and undervaluation as the biggest catalysts for significant gains over the next year. However, he cautions that office REITs have their own dynamics due to vacancy rates remaining elevated amid the increase in remote and hybrid work.
REITs benefit in two ways from lower rates - their yields become more attractive to investors on a relative basis, and it leads to lower financing costs. Hill points to improving credit markets as another reason to overweight the sector in the coming year. This means REITs will have an easier time accessing credit which will lead to more activity such as acquisitions and new projects. Historically, REITs have outperformed during periods of tightening spreads and falling rates.
Another attractive component of REITs is that valuations are compelling as prices have declined over the past couple of years, while earnings have remained quite stable due to the economy avoiding a recession. Further, most REITs continue to have a relatively low cost of capital due to refinancing at lower rates in 2021.
Finsum: Rich Hill of Cohen & Steers is bullish on REITs for next year. He sees falling rates, tightening credit spreads, and an improving credit markets as major catalysts.
Housing Affordability a Major Obstacle for Prospective Homebuyers
A combination of factors has led to the worst housing affordability in decades. During the pandemic, there was a surge in real estate prices as many moved out of urban locations to the suburbs due to the rise of remote and hybrid work arrangements.
This increase in demand also coincided with a tight supply-demand dynamic as new home construction has lagged population growth ever since the Great Recession and subprime mortgage crisis. Another factor supporting demand is that Millennials are entering their peak consumption years in their 30s and 40s.
Additionally, after more than a decade of low rates, current monetary policy is at its most restrictive in decades. Thus, mortgage rates are now hovering above 7%, while they were at 3% for most of 2020.
According to Andy Walden, the VP of enterprise research for ICE Mortgage Technology, household incomes will have to increase by 55%, home prices decline by 35% with mortgage rates back to 3%, for affordability to revert back to historical norms, or some combination of these factors.
Of course, such dramatic developments are unlikely. Walden believes that inventories are a key leading indicator for home prices. In recent months, there has been a modest bump in listings, but nothing significant enough to affect affordability.
Finsum: A combination of factors has led to housing becoming unaffordable for many prospective buyers, creating a major challenge for the real estate market.
Are There Any Opportunities in Commercial Real Estate?
The Federal Reserve’s tightening campaign surprisingly has had a muted impact on the broader economy as evidenced by continued expansion despite the highest rate in decades. In terms of the stated goal of curbing inflation, results are mixed as well.
However, the vector which immediately responded to tighter policy is real estate given that affordability has declined due to higher rates. In some markets, activity has simply cooled, while in those with poor fundamentals, prices are falling more precipitously.
Within real estate, commercial real estate (CRE) is the most challenged given oversupply and the recent rise of remote work. For Barron’s, Rob Csneryik covers why some contrarian investors are seeing opportunity in the beaten-down sector.
In essence, it’s a buyer’s market with so many traditional sources of funding out of the picture, leading to more favorable terms and higher returns. Further, there is less risk with values already down so much. Many believe that office occupancy rates will start to gradually rise especially if the economy does weaken which would give employers more leverage to force employees back to the office. CRE would also likely benefit from a mild recession as it would compel the Fed to cut rates which would turn a major headwind into a tailwind.
Finsum: Commercial real estate is the weakest segment of the real estate market. However, some contrarians see opportunities amid the carnage.