The widely observed Bloomberg US Aggregate Bond Index is higher by 2.45% year-to-date and some experts believe the Federal Reserve will opt to not raise interest rates at its June meeting.
Positive signs to be sure for the bond market, but not an invitation to be indiscriminate when it comes to fixed income allocations. In fact, some experts believe that with inflation still stubbornly high and jobs growth surprisingly robust, the Fed might not have the luxury of skipping a rate hike at its June meeting. It’s possible the central banks hand remain tied and that it has no choice but to raise rates later this month.
That remains to be seen, but there is a reasonably good chance bond market volatility could creep higher again over the near-term. It already is. The Bloomberg US Aggregate Bond Index’s recent volatility reading shows the gauge in the 97th percentile for that metric.
On that note, advisors might want to consider deploying active management in the ultra-short term duration space. Yields here are surprisingly high and these and the short- and ultra-short duration spectrums afford clients reduced fixed income volatility.
Seizing Upon Short-Term Bond Opportunity
Many clients aren’t well-versed in duration definitions. It’s not their job to be, but advisors can effectively explain duration nuances to them. First, start with articulating that duration gauges a bond’s sensitivity to changes in interest rates.
Next, highlight the differences between short-term and ultra-short term debt. Generally speaking, bonds in the former camp have maturities of one to three years while those in the latter category have maturities of less than a year. Advisors should also point out to clients that the various duration categories apply to all bonds, not just U.S. Treasuries.
“Short-term bonds’ maturity focus, income potential, and volatility profile relative to the broader market may allow investors to strike a better balance between risk and return — particularly for US 1-3 year corporate bonds,” according to State Street Global Advisors (SSGA).
The fund issuer points out an area of attractive opportunity for advisors to discuss with clients: Corporate bonds with short-term maturities. Due to the corporate label, these bonds yield more than comparable Treasuries, but in the investment-grade camp, credit risk is minimal. Plus, there are volatility benefits.
“Not to mention their return volatility profile is 86%, 55%, and 70% less than that of broad stocks, bonds, and credit markets, respectively. And as shown in the following chart, relative to other bond segments, US 1-3 year corporate bonds have the highest yield-per-unit-of-volatility ratio,” adds SSGA.
Mind Mortgages
An asset class accessible via various active and passive mutual funds and exchange traded funds, mortgage-backed securities (MBS) may also be fixed income ideas for advisors to evaluate.
“As a defensive bond sector with a low correlation to stocks, mortgages may allow you to selectively add duration at a yield in excess of US Treasurys,” observes SSGA. “And if the Fed does cut rates toward the end of the year, mortgage rates could fall and reignite refinancing, which has troughed, bringing in duration on mortgages.”
The point: MBS durations and yields are currently elevated relative to historical norms, indicating that any declines to one or both of those figures could provide clients with capital appreciation.