While bonds are generally known for their stability, 2022 marked a deviance from the norm. The question for advisors is, how should they approach 2023? Mariam Kamshad, head of portfolio strategy for Goldman Sachs personal financial management, and Guido Petrelli, CEO, and founder of Merlin Investor spoke to SmartAsset to provide some guidance. First advisors should expect a return to the norm. Kamshad said 2022 was an unusually bad environment for bonds with the Federal Reserve raising rates to a 15-year high. She believes that's unlikely to repeat and expects both yields and capital gains returns to stabilize. Second, advisors should pay attention to inflation and government bonds. Kamshad believes that inflation is still the biggest issue in the economy and expects it to continue slowing in 2023, which would likely slow interest rates. Her team considers duration risk a better bet than credit risk. Kamshad's team also recommends investors consider government bonds. The team expects intermediate Treasurys to outperform cash. They also expect municipal bonds to pick back up. Petrelli recommends following the unemployment rate and the quit rate as they are “good metrics for the strength of the economy overall and a window into where bonds are headed.” He believes a potential recession is one of the biggest questions facing the bond market. In a recession, Petrelli expects investors to favor short-term bonds.
Finsum:According to two portfolio analysts, advisors should expect a return to the norm for bonds, but they should also keep an eye on inflation, government bonds, and the jobs report.
According to Vanguard, investors that allocated part of their portfolios to low-yielding municipal bonds at the beginning of last year should now be looking forward to the prospect of higher income, thanks to a rapid rise in rates. In a fixed-income report for the first quarter, the fund firm wrote, “Following a year with $119 billion of outflows from municipal funds and ETFs, we expect the tide to turn. For high-income taxable investors, we are expecting a municipal bond renaissance.” According to the report, muni bonds only offered yields of around 1% at the start of 2022, compared to yields that now exceed 3% before adjusting for tax benefits. Tax-equivalent yields are at 6% or even “meaningfully higher for residents in high-tax states who invest in corresponding state funds.” Vanguard said that this makes munis a “great value compared with other fixed income sectors and potentially even equities—especially with the odds of a recession increasing.” According to the Vanguard report, muni bonds also remain strong from a credit perspective, with attractive spreads over comparable U.S. Treasurys and corporate debt. In fact, municipal balance sheets are stronger now than they’ve been in two decades, leaving states well-prepared to navigate an economic slowdown.
Finsum:According to Vanguard, higher yields and solid balance sheets make muni bonds a highly attractive option for investors this year.
Principal Asset Management recently announced that it is enhancing its fintech-enabled model portfolios by incorporating individual bonds as an option for the portfolios. The company collaborated with YieldX and Smartleaf Asset Management to offer the only full portfolio direct indexing solution, enabling advisors to expand the capabilities of direct indexing beyond equities to individual bonds. Principal launched fintech-enabled model portfolios last year in collaboration with Smartleaf to make it easy to construct and manage custom portfolios. As part of the announcement, Jill Brown, Principal's managing director of U.S. Wealth Platform, stated, “We are the first asset manager to work with YieldX to incorporate individual bonds into model portfolios, making the combinations of mutual funds, ETFs, individual equities, and now individual bonds available through our 37 model portfolios even more powerful.” Adam Green, CEO of YieldX added “Through the addition of capabilities from YieldX, advisors will now have the option to include individual fixed-income securities.”
Finsum:Principal collaborated with YieldX and Smartleaf to offer individual bonds as part of its direct indexing model portfolios.
Corporate executives are warning that the volatile market, combined with the Fed’s rate hikes and the war in Ukraine will negatively impact fourth-quarter earnings, while analysts have downgraded earnings expectations in every sector. However, there may be a bright spot during earnings season, ETF issuers. According to ETF.com data, ETF flows came in at $203 billion in the fourth quarter, nearly double the third quarter's flows of $105 billion. The increase in flows should help fourth-quarter earnings for ETF issuers. It would also be a reversal from the previous quarter when State Street reported $14 billion in net outflows and Schwab’s ETF revenue declined sharply. ETF inflows at BlackRock’s iShares also fell by more than half compared with the third quarter of last year. The surge in inflows during the fourth quarter can be attributed to the rising demand for fixed-income ETFs. Investors are flocking to bond ETFs as they are considered safe havens during downturns. BlackRock President Rob Kapito said on the company’s third-quarter earnings call, “We're going to see dramatic and large inflows into fixed income over the next year as interest rates rise.” ETF.com data shows that fixed-income funds saw inflows of $61 billion in the fourth quarter, up nearly 13% from the $54 billion in the prior-year quarter.
Finsum:While analysts are predicting a dismal fourth-quarter earnings season, ETF issuers may be a bright spot as fixed-income funds saw inflows of $61 billion during the quarter.
Last month, we wrote about a survey that revealed advisors are seeing the importance of active ETFs since owning passive index-only ETFs left them too exposed to market conditions. Another survey was performed this month showing similar results. VettaFi held a webcast called Active Strategies for Rising Rate Headwinds that featured Franco Ditri and Chris Murphy of T. Rowe Price and Todd Rosenbluth of VettaFi talking about the Fed’s monetary policy outlook and how financial advisors can incorporate active strategies into a bond portfolio. After the webcast, a poll was taken revealing that more advisors are seeing the need to add active management to their portfolios, given the likelihood that the Fed will continue to raise rates. The majority of respondents expect to increase their exposure to active ETF strategies, with 50% being “very likely” and 39% saying they are “somewhat likely.” Of those, 39% of respondents said they would most likely consider high-yield/bank loan funds for exposure, with 27% saying they would consider active short-term bond funds. In addition, 20% are contemplating core-plus and 14% are looking toward core bond funds. If the Fed continues its tightening policy, actively managed fixed-income strategies could help reduce risk.
Finsum:A post-webcast poll revealed that more advisors are seeing the importance of active fixed income with the Fed continuing to pursue a tight monetary policy.
If your clients are invested in Chinese companies and have a preference for ESG, it may be time for a change in their portfolios. It appears sustainability rules in western countries are at odds with what’s happening in China. While Chinese equities offer strong growth potential, their ESG ratings rank lower than western nations and most emerging markets. For instance, Sustainalytics, a sustainable rating agency owned by Morningstar, downgraded three Chinese big-name tech companies on its watchlist in October. The three stocks, Tencent, Weibo, and Baidu, were moved to the category of “non-compliant with UN principles.” In addition, Hong Kong Watch, a UK-based group that researches investment and human rights issues in China, recently said in a report that “many of the biggest asset management, state pension, and sovereign wealth funds were passively invested in companies allegedly involved in the repression of Uyghur Muslims in China’s Xinjiang region.” The report found three major stock indices provided by MSCI included at least 13 companies that “have allegedly used forced labor or have profited from China’s construction of internment camps and surveillance apparatus in Xinjiang.” Another problem is that Chinese companies are less likely to respond to queries from ESG rating agencies.
Finsum:With ESG investing continuing to gain momentum, it appears that many Chinese companies are at odds with ESG due to censorship and repression in China.