Topic Tags: Fixed Income - Investment Grade

2016 Market Preview

January 2016

Similar to previous years, we offer our annual market preview newsletter. Each year presents new challenges to our clients, and 2016 is off to a volatile start with equity markets down significantly, oil dropping below $30, the Fed poised to further increase interest rates, and fears of a China slowdown rippling through the markets. However, other headlines will emerge as the year goes on, and it is critical to understand how asset classes will react to each new development and what such reactions will mean to investors. The following articles contain insightful analysis and key themes to monitor over the coming year, themes which will underlie the actual performance of the asset classes covered.

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How to Position Fixed Income Portfolios for the Rate Hike

October 2015 Investment Perspectives

Much has been written and discussed in the media about when the rate hike will begin and the pace at which it will occur. Ultimately, the timing and pace are difficult to predict because they depend on many moving parts, including unemployment, inflation, and a host of unpredictable economic and political factors. The right question to ask is: How should an institutional investor position a fixed income portfolio for the rate hike, regardless of the associated timing and speed?

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How Have Capital Market Valuations Evolved Over the Last Year?

This week’s chart shows that current valuations across equity and fixed income markets are lower today compared to where they stood at the end of September last year. The big takeaway here is that equities broadly appear to still be cheaper than bonds.

This week’s chart shows that current valuations across equity and fixed income markets are lower today compared to where they stood at the end of September last year. The big takeaway here is that equities broadly appear to still be cheaper than bonds.

Japanese Government Bonds and German Bunds are some of the most expensive debt instruments currently available to investors. As it relates to the former, the Bank of Japan’s unprecedented stimulus has helped push Japanese Government Bond yields to record lows, and earlier this year, yields on securities with maturities up to five years turned negative for the first time. Looking ahead, the Fed’s willingness to delay an increase in U.S. interest rates should support demand for riskier assets and as a result, fixed income valuations may normalize over time. Compared to last year, the most precipitous drop in valuations has taken place in U.S. High Yield, U.S. Credit and U.S. dollar-denominated Emerging Markets Debt.

As it relates to equities, with the exception of the U.S., South Africa, and Mexico, valuations around other parts of the globe are on the lower end of their historical averages.  Finally, valuations in Canadian, Spanish, and Taiwanese equity markets have come down the most over the past year as these markets have sold off over the near term.

Note: Percentile ranks show valuations of assets versus their historical ranges. Example: If an asset is in the 75th percentile, this means it trades at a valuation equal to or greater than 75% of its history. Valuation percentiles are based on an aggregation of standard valuation measures versus their long-term history.

Is the U.S. Economy on the Brink of a Recession?

Historical analysis has shown that an inverted or flattening yield curve may be a warning sign of an upcoming recession. Since the 1950s, an inverted curve has preceded seven of the last eight recessions, with spreads near zero in 1960.

Historical analysis has shown that an inverted or flattening yield curve may be a warning sign of an upcoming recession. Since the 1950s, an inverted curve has preceded seven of the last eight recessions, with spreads near zero in 1960. An inverted yield curve occurs when short-term yields to maturity are higher than long-term yields to maturity (depicted where spreads fall below zero on the chart). This indicator has proven to be a reliable predictor of recessions and future economic activity.

Last week’s correction has led to investor concern that the market will continue to decline and evolve into a bear market, which is unlikely unless there is a recession and corresponding inversion of the yield curve. This week’s chart shows that the yield curve is currently positively sloped and has in fact steepened on a year-to-date basis, providing some confidence that recent market volatility is indicative of a correction rather than another recession.

Creating Social Impact Through Responsible Investing

August 2015 Investment Perspectives

A growing population of socially conscious investors has energized socially responsible investment (SRI) strategies in the past decade. The Forum for Sustainable and Responsible Investment defines SRI as the process of integrating personal values and societal concerns into investment decision making. SRI has increased in the U.S. from $639 million in 1995 to $6.6 trillion in 2014. These assets account for roughly 17% of total dollars under management in the U.S.

This newsletter outlines a brief history of SRI, approaches to implementing an SRI program including positive and negative screening and shareholder activism; impact investing; example products and solutions in equities, fixed income, and real estate; investor concerns around performance and fiduciary liability, and considerations for implementing a sustainable investing program.

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Which Equity Sectors are Most Sensitive to Rising Interest Rates?

Over the past few years there has been much discussion on the low interest rate environment and what will happen once interest rates begin to rise. Though the Fed has delayed raising its overnight lending rate for far longer than many people initially expected, it seems likely that it will finally begin to raise rates later this year. Coupled with the fact that the 10 yr Treasury yield is once again below 2% and approaching its historical low, an increase in interest rates seems very likely.

Over the past few years, there has been much discussion on the low interest rate environment and what will happen once interest rates begin to rise. Though the Fed has delayed raising its overnight lending rate for far longer than many people initially expected, it seems likely that it will finally begin to raise rates later this year. Coupled with the fact that the 10 yr Treasury yield is once again below 2% and approaching its historical low, an increase in interest rates seems very likely.

This Chart of the Week examines what has happened historically to the sectors of the S&P 500 index when rates on the 10 yr Treasury rise substantially. The chart compares the average monthly returns during seven rising rate periods to the average monthly returns during this entire timeframe. As a whole, the S&P 500 has generally outperformed during these time periods, along with most sectors. Industries that tend to be more cyclical, such as information technology, consumer discretionary, and materials featured the largest outperformance. On the other hand, more conservative sectors failed to beat their averages, with utilities and telecom delivering negative monthly returns. Though it is important to remember that historical results may not always persist in the future, the largely positive returns shown in the chart should help ease the fears of an equity market correction when rates begin to rise.

3Q15 Rate Hike and Yield Curve Flattening Expected – Marquette Associates Survey

February 2015 Investment Perspectives

Consensus among market prognosticators is that the Federal Reserve (“Fed”) will raise interest rates this year. However, there is less agreement about when rates will start to rise, as well as how the shape of the yield curve will shift as rates start to ascend. To gain a better sense of when the rate hike can be expected to begin as well as how the shape of the yield curve is expected to change, we surveyed 41 fixed income investment management firms, large and small, for their best estimates based on the current market environment. In addition, we collected responses on when to expect a major credit spread widening, i.e., when we should expect major defaults from corporate bond issuers given the re-leveraging that has taken place over the last eight quarters. We also obtained from the respondents their expectation as to which region of the world might provide the best fixed income returns in 2015.

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2015 Market Preview

January 2015

Similar to previous years, we offer our annual market preview newsletter. Each year presents new challenges to our clients, and 2015 is no different: U.S. equities are at all-time highs, uncertainty reigns for international equities, and to everyone’s surprise, interest rates fell dramatically in 2014…but are poised to rise from historic lows over the next year. In the alternative space, real estate remains a solid contributor to portfolio returns, and private equity delivered on return expectations, though dry powder is on the rise. Hedge fund results were mixed, but have shown to add value in past rising interest rate environments. Further macroeconomic items that bear watching for their potential impact on capital markets include the precipitous fall in oil prices, the strengthening U.S. dollar, job growth, and international conflicts.

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Volatility Index Spikes in August

This week’s chart of the week takes a closer look at the CBOE volatility index (“VIX”) and the German implied volatility index (“VDAX”) in light of recent geopolitical events. Volatility indices are often describes as “fear indices” that tend to increase with market uncertainty.

This week’s chart of the week takes a closer look at the CBOE volatility index (“VIX”) and the German implied volatility index (“VDAX”) in light of recent geopolitical events. Volatility indices are often described as “fear indices” that tend to increase with market uncertainty.  As uncertainty increases, investors typically prefer the safety of U.S. Treasuries, driving up bond prices and pushing yields lower.

• On August, 1st, President Obama announced sanctions on Russia; VIX and VDAX reached their highest levels in more than five months over concern of Russian retaliation.
• On August, 7th, President Obama authorized a targeted strike against Iraq; triggering the VDAX to reach the highest level of the year as concern over global equity markets lead investors to push the 10-Year Treasury yield to 2.43%.
• Finally, August, 15th marked the fall of the 10 Year-U.S. Treasury yield to the lowest in 14 months at 2.34%, due in part to the global tension in Ukraine and conflict in the Middle East.

After spiking in early August on geopolitical worries, the VIX has returned to more normal levels seen throughout most of the year. However, with many of the geopolitical hotspots right on Germany’s doorstep, German market volatility has remained elevated. While U.S. investors may have put the latest crisis behind them, it is worth noting that markets closer to the epicenter of the conflict are not as sanguine.

Fixed Income, (Eventually) Rising Rates and the (Non) Universal Law of “Bond Gravity”

In describing some of the strategies and portfolio frameworks that investors could consider for the management of their duration, liquidity, and credit exposures in anticipation of rising rates, we will address the potential benefits and also highlight some likely risks that should not be overlooked.

While we cannot predict exactly when and by how much rates will rise, the Federal Reserve (“Fed”) has recently signaled that we could see a modest increase in the fed funds rate by mid-2015. Given the increased possibility of rates rising over the next few years, investors should not retreat in fear from bonds en masse or look to underweight their fixed income allocations to anemic levels. Instead, they should continue to view fixed income as strategically important: after all, fixed income is a broad asset class with a diverse opportunity set. And, while we will summarize our views on some different sub-asset classes in this paper (including floating rate bonds, non-U.S. debt and convertibles), for additional reading on non-core fixed income sub-asset classes, please refer to our previously released papers on global fixed income, emerging markets debt, high yield, and senior secured loans.

In respecting the broadness of our client base, we seek to avoid a one-size-fits-all narrative on how they could look to manage their bond allocations: some clients will be limited in their ability to access certain sub-asset classes while others will have ample room and resources to maneuver across the choice spectrum. Consequently, there are a number of prudent approaches and strategies for these different types of investors to explore as a means of hedging their interest rate risk. The key is establishing which portfolio framework or sub-asset class exposure is the best fit for their programs and in line with their circumstances, risk tolerances, and investment goals.

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