Markets
Active management seems to be making a comeback, and adding to that rising rates have many investors eyeing fixed income. For overall active funds in 2020 and 2021, it was a nearly a 50/50 shot that they would outperform similar passive counterparts; in other words virtually no advantage. However, research shows that passive equity has an advantage but over the past 10-years active fixed income leads the way over passive funds. In the last decade, the average bond manager beat the Bloomberg Aggregate Bond Index nearly three-fifths of the time. However, fixed incomes risk mitigation isn’t captured here, and active funds have the advantage to adjust the risk factor over passive funds, carrying an additional advantage.
Finsum: The ultra-low interest rate environment has been the difference-maker for fixed income managers who have just capitalized better than passive funds.
Inflation surged to a nearly 40-year record high as the CPI index annual inflation pushed to 7.5%. This number was well above expectations and even core inflations 6% posting came in higher than consensus. In response, the Fed is going to tighten and do so significantly as regional Fed Presidents are expecting a 1% rise in the Fed Funds rate. This is a seriously hawkish turn and given there are only 3 more FOMC meetings with projections that would imply a 50-basis point rate hike possibility. The fed hasn’t hiked rates that quickly since the turn of the century. Investors are saying the Fed will want to hike by 50-basis points to keep its credibility.
Finsum: Hikes that steep could destroy the record recovery the US has had, it could lead to major windfalls in equities markets.
Everyone and their dog has been pivoting to ultra-short duration pseudo-cash bond ETFs in the fixed income balance of their portfolio and this is causing a sell-off of lots of corporate bond ETFs. LQD saw its fifth day of outflows which set a pandemic era record. This brought together a total of $856 million in investor outflows. This is part of a blogger trend where sentiment around investment-grade bonds is weakening. However, it's not because they are less likely to pay back but more a reflection of investment-grade corporate debt generally having a longer duration, which is the risk investors don’t want with upcoming rate hikes.
Finsum: The risk premium hasn’t changed with corporate debt just the term structure risk. Fundamentally these bonds could still be in a good place.
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That's correct, Joe Biden’s latest economic rebrand is really a diet version Ronald Reagan era policy. In a recent statement, Joe Biden said that in response to inflation we can either “increase the supply of cars” or “reduce demand for cars by making Americans poorer”. This is essential supply-side economics made famous by the Reagan administration. Additionally, Yellen coined the term ‘modern supply-side’ economics just two weeks later in order to push the Build Back Better bill. This is a liberal tilt on aiding the weakening supply chains that will hopefully strengthen the economic recovery. It's a response to republicans’ attacks that BBB will surge debt and inflation.
FINSUM: The economy is in a difficult place, there is still catch up needed but undoubtedly Americans are feeling the force of inflation and another stimulus package could only further that problem.
More so than inflation, interest rate risk is the biggest factor in bond markets. If the Fed hikes and Yields rise then that will only lower the value of many bond ETFs. In response, many investors have turned to shorter-duration fixed income. However, the latest surge is off the charts. Lots of money is flowing into ultra-short cash like ETFs with the lowest duration treasuries. Investors are offloading even medium-duration treasuries in the five-three year window. PIMCO’s MINT saw almost $900 million in inflows setting a record week for the fund. Investors are just looking to store capital in the midst of all the interest rate risk in the economy right now.
FINSUM: It's unclear if one rate hike or two will send yields surging high enough, now might be the time to hold medium duration debt as a lot of the risk could be priced in.
The fixed income ETF market took a hit in 2020, and it's been a very slow recovery. Still, active funds outperformed during this time period, and that trend could continue into 2022. A stand-out active bond ETF to consider is Fidelity Total Bond ETF. it’s seen stellar performance when compared to its peers and its managers are committed to ensuring liquidity. Another ETF to watch out for is Pimco enhanced Short Maturity Active ETF. This fund is more centered around stability and security with less risky management. However, avoiding high yield corporate debt and currency risk these factors can make it a safer alternative in the upcoming cycles.
FINSUM: Shorter duration active bond ETFs are really important to consider right now because they mitigate the single biggest risk that exists in bond markets: rising rates.