I attended last week’sInsideETF conferencein Florida – theworld’s largestETF conference. I was lucky to be one of thepresenters. I also sat in a few sessions to hear specifically what fixed income portfolio managers were saying. The majority of them made a case for owning the asset class (not surprising) which I completelydisagreewith.
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I can’t help butworryabout investors who are long bonds. Judging by the$2 trillionof inflows into bond funds since 2009, there are quite a number of them.
Trump's tax plan isinflationaryin nature and inflation is justplain awfulfor bond holders. Interest rates have found a bottom and are rising as economic growth around the world improves. Again, not a good combination for bond holders.
The people who purchased$2 trillionof bonds unfortunately have paid some pretty horrendous prices for them. Your entry point iseverythingin this game.
Luckily, investors ofAstoriadon’t have to worry because we have modeled for this since day 1. From the day Astoria was launched, we have been vocal in saying that we want to ownas little fixed income exposure as possiblefor our investors.
To be clear, we do own a very small amount of bonds but its 1) mostly out of benchmark (so funding risk is minimized if the $2 trillion inflows reverse) and 2) what we do own is short duration.
The real story and value add of what Astoria is doing is that we arereplicating the risk characteristicsof fixed income securitiesvia other asset classes.For elements of carry, we are using commodities and emerging market debt. For diversification and hedging, we are using liquid alternatives, gold, and the long bond (the latter is less than 2.5% of our portfolio).
To generate income for our portfolio, we are using non traditional fixed income segments such asleverage loans,preferred equities, andhigh yield munis. We argue there isfar less credit and interest rate riskin these securities compared to the standard fixed income indices.
Below is an extract fromour 2018 year ahead outlookwhich specifically addressed Fixed Income (published on Dec 6, 2017). I am also attaching a link to a podcast I recorded on Dec 8, 2017 withJeremy Schwartz, Director of Research of WisdomTree,where I discussed our bearish views on Fixed Income. https://soundcloud.com/user-20931378/behind-the-markets-podcast-john-davi-bruce-lavine
Key Theme #8: Be Incredibly Selective In Fixed Income
oBonds were atremendousasset class to own in the 70s, 80s, and 90s.All you needed to do is buy the Aggregate Bond Index and you got (1)high income(2)diversification(3)hedging(4)carry.What more can you ask for?Hence, a spectacular bubble forms.
oUnfortunately, in recent years because of the apparent “low growth & low return world” that we“supposedly”have been living in since the Credit Crisis, investors flocked into bond funds to the tune of$2 trillionof inflows.Sadly, in doing so, thevast majority of the equity bull market was missed by investors(at least from 2009 to 2016; post Trump’s election positioning has changed significantly).
oBuying the Aggregate Bond index nowis neither a risk reduction tool(duration has increased & correlations to stocks have increased)nor an income play(yield is only 2.5%).As far as diversification, common sense should tell you that if$2 trillion of inflowsgoes into any asset class, itno longer will provide the diversification benefits it may have done several decades ago.
Bonds Are No Longer the Risk Reduction, High Income, & Uncorrelated Asset They Were Decades Ago
Source: Bloomberg, Astoria
The Duration of Bloomberg Barclays Aggregate Bond Index Has Increased in Recent Years
Source: Bloomberg, Index IQ, Astoria
oAstoria has written extensively why we utilizePFF (iShares U.S. Preferred Stock),SRLN (SPDR Blackstone/GSO Senior Loan), EMB (iShares J.P. Morgan USD Emerging Markets Bond), andHYD (Van Eck High Yield Municipal).None of these are providing the opportunities they did years ago but they offer a modestmargin of safetyand their yields aredoublethat of the Aggregate Bond index.For inflation protection, we preferTIPsandcommodities. And for hedging market risk, we prefer going outside of fixed income.
oThe pushback we get on owning the long end of the curve is that the Fed owns a ton of long dated maturities. However, from our perch the Fed isn’t selling those bonds but instead allowing them to roll off.The real risk for backend is if inflation picks up significantly.
oThelong end isn’t priced for inflationas forward rates all top out around 3% which is the Fed’s long-term dot in the SEP.If inflation picks up, then the long-term dots should go up.Subsequently, the market inflation expectations can rise which will raise nominal rates and term premiums.
oThe back end of the US curve isstillsignificantly higher yielding then most other developed bond markets.In Astoria’s view, the demand for the back end will continue until other Central Banks stop their QE programs and international yields back up.
To read our entire 2018 outlook piece, refer to the following link: https://www.astoriaadvisors.com/single-post/2017/12/06/8-ETFs-for-2018
Any ETF Holdings shown are for illustrative purposes only and are subject to change at any time.For full disclosure, please refer to our website:astoriaadvisors
