Topic Tags: Fixed Income - Below Investment Grade

Deciphering the Bond Markets: How Much Duration and Credit Risk Should I Take?

2018 Investment Symposium flash talk by Ben Mohr, CFA

Given the current fixed income environment of rising rates and tight credit spreads, investors are questioning how much interest rate risk and credit risk they should hold in their portfolios. This session addresses the questions of how much duration (interest rate risk) and credit risk investors should take by examining current market conditions, anticipated changes, and an overall assessment of where we are in the credit cycle.

A summary of this flash talk can be downloaded here.

A “Halftime” Review of Asset Allocation for 2018

As of June 30th, the Russell 3000 index was up only 3.2%, a far cry from its 10-year annualized return of almost 9%; the MSCI ACWI ex-U.S. ­— a broad proxy for international stocks — has been even more disappointing, down 3.8% compared to its 2017 return of 27%. Furthermore, most bond strategies are negative for the year, thus dispelling the notion of diversification. However, the year is only halfway complete and as we have seen repeatedly in the capital markets, fortunes can change rapidly and unpredictably. In an effort to formulate explanations and expectations, the following newsletter investigates the disappointing performance from the first half of the year, as well as potential outcomes for the remainder of 2018.

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The opinions expressed herein are those of Marquette Associates, Inc. (“Marquette”), and are subject to change without notice. This material is not financial advice or an offer to purchase or sell any product. Marquette reserves the right to modify its current investment strategies and techniques based on changing market dynamics or client needs.

Socially-Responsible Fixed Income Investing

Socially-responsible investing (SRI) is one of the fastest-developing segments of investing and we see a ballooning trend of true action taken by investors. Specifically for fixed income, socially-responsible investing is growing and a great deal is evolving in the recent landscape, particularly in terms of philosophical changes as well as the development of new products where “the rubber meets the road.”

This white paper explores trends in socially-responsible fixed income investing and assesses the challenges. In addition, we examine the prevalence of Environmental, Social, Governance (ESG) issues and compare their uses in fixed income versus equities. Finally, we evaluate methods to invest in fixed income for the responsibly-minded investor.

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The opinions expressed herein are those of Marquette Associates, Inc. (“Marquette”), and are subject to change without notice. This material is not financial advice or an offer to purchase or sell any product. Marquette reserves the right to modify its current investment strategies and techniques based on changing market dynamics or client needs.

2018 Market Preview

Each year, investors face numerous questions that can impact their portfolios, and 2018 is no different. How will tax reform further impact the capital markets? How much – and often – will the Fed raise rates in the coming year? Can international equities continue to outperform their U.S. counterparts?  Should we be concerned about the levels of dry powder in the private equity market? These topics among many others are covered in the following articles as we offer our annual market preview newsletters. In the links below, readers will find a preview newsletter for each asset class that we cover, as well as a general U.S. economic preview. Each article contains insightful analysis and key themes to monitor over the coming year, themes which will underlie the actual performance of the asset classes covered. We hope that this set of articles can assist you and your committees as you plan for 2018. Should you have any questions about any of the content, please feel free to contact myself or any of the authors or consultants here at Marquette. We also have a webinar recording available by request if you would like to hear a high-level presentation of the topics presented in these articles. Happy New Year!

U.S. Economy by Jeffrey Hoffmeyer, CFA, Lead Analyst, Asset Allocation

Fixed Income by Ben Mohr, CFA, Senior Research Analyst, Fixed Income

U.S. Equities by Samantha T. Grant, CFA, CAIA, Senior Research Analyst, U.S. Equities & Rob Britenbach, CIPM, Research Analyst, U.S. Equities

Non-U.S. Equities by David Hernandez, CFA, Senior Research Analyst, International Equities

Real Estate by Jeremy Zirin, CAIA, Senior Research Analyst, Real Assets

Infrastructure by Jeremy Zirin, CAIA, Senior Research Analyst, Real Assets

Hedge Funds by Joe McGuane, Senior Research Analyst, Alternatives

Private Equity by Derek Schmidt, CFA, CAIA, Senior Research Analyst, Private Equity

How Will Tax Reform Impact Asset Class Returns?

On December 20, 2017, Congress passed the final version of the Tax Cut and Jobs Act (H.R. 1).  This tax reform bill is estimated to be a $1.5 trillion tax cut and represents the most significant reform to the U.S. tax code since the 1986 tax cut passed under President Reagan.  This newsletter will address the most important changes as it relates to the economy, markets, and our client portfolios.

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The opinions expressed herein are those of Marquette Associates, Inc. (“Marquette”), and are subject to change without notice. This material is not financial advice nor an offer to purchase or sell any product. Marquette reserves the right to modify its current investment strategies and techniques based on changing market dynamics or client needs.

When Popularity is an Achilles’ Heel: Bank Loan Re-Pricings

Through October, bank loans are up only 3.7% compared to high yield’s 7.5% return, and the disparity between the two below-investment grade strategies has surprised some investors. The root cause of bank loans’ relatively disappointing returns is re-pricings, which tend to offset the floating rate value proposition of bank loans. Re-pricings have preserved the absolute value of bank loan yields, even with LIBOR rising to its current level of 130bps. As a result, bank loan returns have been muted this year, despite the credit rally in 2017.

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The opinions expressed herein are those of Marquette Associates, Inc. (“Marquette”), and are subject to change without notice. This material is not financial advice nor an offer to purchase or sell any product. Marquette reserves the right to modify its current investment strategies and techniques based on changing market dynamics or client needs.

Will the Fed “Normalize” My Investment Returns?


Flash talk by Ben Mohr, CFA at Marquette’s 2017 Investment Symposium

In this session, we review common terms and concepts in fixed income including Fed rate hikes and the Fed’s balance sheet, and explore how each concept can assist investors in modeling bond returns. We also examine potential outcomes of the upcoming change in Fed leadership and FOMC and impacts on client portfolios.

Healthcare Organizations’ Top 3 Investment Concerns for Balance Sheet Assets

Historically, healthcare organizations have covered their cost of debt by investing in a conservative mix of fixed income securities. However, for most of the recovery since the Great Recession, the yield on their debt payments exceeded the Bloomberg Barclays Aggregate (Agg) bond index yield. Therefore, many organizations were forced to consider riskier assets to cover their debt payments as a result of this adverse spread. Now that the Federal Reserve rate hikes are underway, Agg yields are once again approaching parity with healthcare issuer debt yields and thereby reducing the pressure to invest in riskier assets to make up for the spread disparity.

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Central Bank Balancing Act

The Federal Reserve continues to signal its intention to reduce its $4.5 trillion balance sheet, with the markets anticipating the first move to occur in September. Much of the liquidity, and consequently, asset returns, in the global markets today could be attributed to the substantial bond and other securities purchases made by the major central banks, thereby ballooning their balance sheets.

Our chart this week shows the Federal Reserve (Fed), European Central Bank (ECB) and Bank of Japan (BOJ) balance sheets over time, totaling $14 trillion today. While the Fed has effectively stopped growing its balance sheet since 2014, the ECB and BOJ continue to expand their balance sheets. With the U.S. enjoying the strongest economy relative to Europe and Asia, the Fed will be the first to taper its balance sheet. This move would effectively slow down stimulus in the U.S., with the ECB and BOJ’s balance sheet tapering to follow at some point in the future when their economies have resuscitated. The Fed has been broadly communicating the mechanics of its tapering, and we expect the markets to respond relatively moderately to the first reduction event.

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The Re-Price is Right

Bank loans provide investors with many advantages, chief among them a floating rate feature that resets on a quarterly basis, benefiting the investor as interest rates rise. They also offer a senior secured top-of-an-issuer’s-capital-structure positioning, meaning that the bank loan investor has first-in-line access to the issuer’s assets should something go wrong. However, recent market dynamics have produced a phenomenon that cuts into bank loans’ attractiveness: re-pricings. A re-pricing is a renegotiation performed by the bank loan issuer with its bank loan investors. Typically occurring in rising rate periods, the re-pricing lets the bank loan issuer reduce the spread that makes up the total coupon it has to pay under its bank loan agreement. An example representative of several recent re-pricings is shown in this week’s chart.

The chart shows two time periods: one year ago (before re-pricing), on the left, and today (after re-pricing), on the right. One year ago, LIBOR, the base rate, was at 1.0%. The spread was 4.0%, making the total coupon, or yield, 5.0%. After the re-pricing on the right, as LIBOR increased from 1.0% to 1.5%–a direct result of the Federal Reserve’s recent rate hikes–the issuer has successfully renegotiated the spread from 4.0% to 3.5%. The total yield then remains at 5.0%. Bank loan issuers get to re-price only if the price of their bank loan exceeds par value, typically 101, and they can initiate re-pricings only after the non-call period ends, which typically lasts six to twelve months after issuance. High yield bonds, on the other hand, have much longer non-call periods, typically five years.

Currently, we are seeing large amounts of bank loan re-pricings. This is because of strong demand for bank loans, including re-priced bank loans, and a lack of supply in the form of new issuance due to low mergers and acquisitions activity, as the issuance of new bank loans is typically how an acquirer finances a take-over. Investors currently have an appetite for re-priced bank loans that is keeping the total yield after the re-pricing approximately equal to the total yield before the re-pricing. This phenomenon explains why bank loan spreads have remained close to their long term averages, as investors have not completely rushed into bank loans, which would have made spreads much tighter. We continue to recommend bank loans as a short-term and long-term allocation due to their moderate spread level, relatively strong yield (currently averaging 5.0%), and the aforementioned floating rate and senior secured features. As M&A activity picks up, we expect more new bank loan issuance, which would reduce the proportion of re-priced loans in the market, thereby raising overall yields on bank loan investment portfolios.

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