Fixed income has been perhaps the big story so far this year in asset management, delivering on the “income” part of the name with very appealing assets on the market. With yields plentiful in products that don’t require nearly as much risk as investors once had to take to find those yields, it’s worth hearing from fixed income analysts like American Century vice president and portfolio manager Balaji Venkataraman on duration, yield, income, and more for 2023.
Speaking with VettaFi on a range of topics in the world of fixed income, Venkataraman discussed how to look at duration in bonds as well as how American Century is looking at T-bills, corporates, and mortgage-backed securities. The firm’s portfolios that are benchmark relative are max overweight duration versus its guidelines.
“I would say in terms of duration, we are expecting intermediate Treasury yields, so call it the seven-to-10-year part of the curve, to continue to trend downward over the next six to nine months, really the rest of this year,” Venkataraman said. “So, with that in mind, we’d be pushing our clients to be adding duration in this environment.”
American Century’s base case still includes a recession, Venkataraman explained, but even without a recession, as long as there’s an economic slowdown, Treasury yields will likely continue to drop thanks to growing demand. For those looking to buy into the duration story, he added, a core fixed income strategy like the firm’s Diversified Bond Fund (ACBPX) could fit the bill.
The firm also offers a core fixed income ETF from its Avantis Investors brand, the (AVIG ).
Overall, the firm is encouraging clients to prioritize taking on more duration risk and less credit risk in this market environment, he concluded. Another factor to consider, too, in locking in duration yield is that front-end yields may start to drop off once the Fed hits a peak rate in May or June.
On Corporates and Mortgage-Backed Securities
Earnings season has started without the tide of bad news that many market watchers may have initially expected. In response to a question about how to parse that in terms of corporate bond investing and corporate bond risk, Venkataraman underscored that the market may not be yet pricing in a slowdown in earnings.
“The way that those earnings are priced in right now, whether it’s the equity market, or the credit spreads in the corporate market — yeah. It’s not priced for any sort of slowdown in earnings, let alone the economic cycle,” Venkataraman said. “So it’s really not correcting.”
While watching for margins compressing following rising costs and wages last year, the real signal would be when corporations outside of tech and finance to an extent also engage in layoffs, he noted, adding that it would be a double indicator that corporate margin pressure is in place and that a recession has arrived. For those investors with a long time frame, there are, however, some attractive yields in investment-grade corporate bonds.
“As recession pricing happens, and we see those broader layoffs, profit margins continue to come down, credit spreads should widen, there should be a better entry point for both investment-grade and high yield corporate,” he added.
The firm also upped its agency mortgage-backed securities weight as valuations became more compelling in the fall. American Century had set a max underweight for agency mortgages in the spring of 2022 as refinancings slowed down amid rising rates.
On Income and Using Fixed Income ETFs
A popular part of the fixed income landscape has been current income this year, with three strategies at American Century offering slightly different views on the space. The newest, the (FUSI ), combines a floating-rate response with interest rates while providing income with less exposure to the riskier parts of fixed income and a bigger focus on quality.
“You’re getting more of a capital preservation benefit in addition to the income with that, but you’re still getting a floating-rate concept, and the floating-rate advantage is going to be most valuable in a rising rate environment,” Venkataraman said. “For those clients who just really want high-quality, no-duration income, FUSI can make a lot of sense right now — in a rising rate environment, it’s going to make a lot more sense for even a broader set of people.”
FUSI is joined by both the (SDSI ) and the (MUSI ). SDSI takes a more go-anywhere approach with a strong income focus and less interest rate risk with a two-year duration, while MUSI is perhaps the most credit risk-related and return-seeking in the trio with more duration than SDSI.
Overall, Venkataraman underscored the need to rethink fixed income for client portfolios — specifically, that core fixed income funds don’t need to stretch into higher exposures in areas like high yield, emerging markets, or non-U.S. dollar-denominated debt to get 5% yields, though standalone allocations to high yield and emerging markets debt can make sense based on risk and return preferences.
Investors and advisors can use fixed income ETFs to get a more tax-efficient exposure to various fixed income asset classes, he said, though he advised against using fixed income ETFs as a trading instrument due to bid/ask spreads they can incur.
“Don’t think of an ETF as anything different than a mutual fund other than a more tax-efficient, lower-cost vehicle that’s advantageous to you and your clients,” Venkataraman said.
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