Topic Tags: Fixed Income - Investment Grade

Fixed Income Indexing: A Commitment to the Bottom

The equities market has experienced a tectonic shift from active to passive investing, with passive investors benefiting from index strength and meaningful fee savings. In fixed income, however, investing in indexing strategies tends to be a commitment to the bottom. The Bloomberg Aggregate Index — the standard index for broad fixed income investing — tends to underperform most active strategies. While there may be shorter time periods where active managers trail the index, over longer time periods the index generally falls within the bottom quartile of universe performance and often in the bottom decile.

Due to the size of and inefficiencies within the fixed income market, there should be many opportunities for managers to take active risks and generate excess returns. Two common active management strategies for aggregate mandates are core and core plus, differentiated by the level of active risk and return objectives. Core strategies should be expected to outperform the index by 50–100 bps and core plus by 100–150 bps over a full market cycle. The vast majority of active managers outperform the index. In the core plus universe, the index’s rolling 5-year return was in the bottom quartile 14 of the last 20 years and in the bottom decile in 10 of those years. In the core universe, where the level of active return is lower, the index on a rolling 5-year basis was in the bottom quartile in 11 of 20 years.

To be fair, there are times when indexing pays. Many fixed income managers are “active” by systematically overweighting corporate and structured credit while underweighting Treasuries and agency mortgages to create a yield advantage. Outyielding the benchmark works well until it doesn’t. During risk-off periods of spread widening, the index tends to be one of the better performers within the universe. The two best examples of this are 2002 and 2008, when markets experienced a precipitance of spread widening due to the dot com bubble bursting and the sub-prime mortgage crisis, respectively. Those periods erased years of prior active management outperformance, though having a yield advantage remained beneficial longer-term, with those active managers outperforming in subsequent years.

While active is often the preferred method of accessing the fixed income market, an aggregate indexed strategy may be helpful as a risk management tool and indexed options may help investors take more tactical positions within fixed income sub-asset classes. Overall, investors should make sure they understand the risks and benefits of investing in active versus passive within fixed income and work with their consultant to create a portfolio that best serves their needs.

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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.

 

An Investor’s Holiday Wish List

Hopefully not another year of coal
In the spirit of holiday fun — and an effort to put 2022 investment returns behind us — we have put together our investor wish list for 2023. We have broken the wish list into two categories: the “must-haves,” which carry the most weight and are most observable, and the “stocking stuffers,” which may not be headline grabbers but are nonetheless impactful across economies and markets. Predictably, the “must-have” items focus on a reversal of the major trends that drove the markets this year; we “must have” a better outlook across at least some of these topics. The “stocking stuffers” category is a variety of topics that either directly impact the major trends from 2022 or are more targeted with their impact on specific asset classes. And while we recognize this is not an exhaustive list, we feel strongly that if these wishes come true we can all feel better about market returns in 2023.

This year’s must-haves:

  • Lower inflation
  • Less aggressive Fed policy leads to fewer interest rate hikes in 2023
  • Avoid a deep recession
  • Resolution of geopolitical conflicts

And stocking stuffers:

  • Broad-based earnings in the U.S. stock market
  • A weaker U.S. dollar
  • Credit defaults start to flatline
  • Slowdowns in hiring and wage growth
  • Favorable news out of China
  • History repeats itself

Read > An Investor’s Holiday Wish List

 

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.

Rising Stars are a Bright Spot in 2022

While 2022 has been an exceptionally challenging year, with both equities and fixed income down meaningfully, there are a few bright spots within the high yield space. The number of rising stars, which are below investment grade securities (high yield) that have been upgraded to an investment grade rating, has already hit 2021 levels with two months remaining in the year. Fallen angel securities — previously investment grade businesses that have fallen to high yield or “junk bond” status — remain relatively low. The increase in rising stars over the last two years comes after a big increase in fallen angels in 2020, and has been driven in part by a recovery in economic activity following the pandemic and better financial discipline of management teams. Many companies used the period of incredibly low interest rates to shore up balance sheets and push out debt maturities. A company’s credit rating changing from high yield to investment grade is significant, especially when facing a slowdown, as it allows the company to better access funding in the capital markets. The number of rising stars is a good trend in credit and quality overall in high yield has improved. Paired with the most attractive yields in years, the forward outlook looks promising in credit.

Print PDF > Rising Stars are a Bright Spot in 2022

 

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.

Q3 2022 Market Insights Video

This video is a recording of a live webinar held October 27th by Marquette’s research team, featuring in-depth analysis of the third quarter of 2022 and risks and opportunities to monitor in the coming months.

Our Market Insights series examines the primary asset classes we cover for clients including the U.S. economy, fixed income, U.S. and non-U.S. equities, hedge funds, real estate, infrastructure, private equity, and private credit, with presentations by our research analysts and directors.

Sign up for research alerts to be invited to future webinars and notified when we publish new videos.
For more information, questions, or feedback, please send us an email.

It’s Always Darkest Before the Dawn

Diversification has been said to be the only free lunch in investments. Since the inception of the Lehman/Barclays/Bloomberg Aggregate index,¹ there have been only 18 of 187 quarters (9.6% frequency) with negative returns in both the bond and equity markets, as measured by the Aggregate and S&P 500 indices, respectively. Comparable results are seen in the monthly data: Of 561 months, only 83 times did both the fixed income and equity markets deliver a negative total return (15.2% frequency). Over the last 45+ years, there has never been a calendar year that recorded negative returns in both indices, though that looks likely to change this year.

This newsletter analyzes 2022’s equity and bond market performance and the importance of diversification and discipline amid such negative momentum.

Read > It’s Always Darkest Before the Dawn

¹Actual data goes back to 1986; backfilled data back to 1976

 

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.

Livestream Videos: 2022 Investment Symposium

The presentations by our research team from Marquette’s 2022 Investment Symposium livestream on September 23rd are now available. Please feel free to reach out to any of the presenters should you have any questions.

View each talk in the player above — use the upper-right list icon to access a specific presentation.

 

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. Past performance is not indicative of future results. For full disclosure information, please refer to the end of each presentation. Marquette is an independent investment adviser registered under the Investment Advisers Act of 1940, as amended. Registration does not imply a certain level of skill or training. More information about Marquette including our investment strategies, fees and objectives can be found in our ADV Part 2, which is available upon request.

The Currency Conundrum

The U.S. dollar is the strongest it has been in a generation. The U.S. dollar index is up almost 11% this year against a basket of global reserve currencies with the greenback reaching parity with the euro last week for the first time since 2002. Like many things in financial markets, interest rates tend to be one of the most significant drivers of currency valuation, specifically the interest rate differentials between global central banks. As the Federal Reserve has pivoted to a more hawkish stance to tame decades-high inflation, other central banks, including the ECB and BOJ, have been slower to respond. When capital can flow freely, investors tend to flock to higher-yielding assets as interest rates rise, which leads to appreciation of the higher-interest rate country’s financial account and increases demand for the domestic currency — in this case, the U.S. dollar.

The Japanese yen is down roughly 16% year-to-date and is the worst performing major currency relative to the U.S. dollar. In an effort to fight decades-long deflation, the Bank of Japan has committed to holding down short-term interest rates, resulting in significant currency devaluation. Japan is the largest foreign holder of U.S. Treasuries, with $1.3 trillion as of January 2022. As the U.S. dollar strengthens, it becomes more expensive for Japan to continue to purchase on-the-run Treasury issuances, which could put further upward pressure on U.S. rates at the same time the Fed is lifting the benchmark fed funds rate and engaging in quantitative tightening. The question of what will happen when the two largest buyers of U.S. Treasuries — the Federal Reserve and the Bank of Japan — both remove liquidity from the market is another unknown that could add to market volatility in the near term.

Print PDF > The Currency Conundrum

 

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.

Halftime Market Outlook: A Mixed Bag

Last week, we hosted our “Halftime” Market Insights Webinar. As the host, my job was to introduce the analyst for each section and then summarize his or her comments before moving to the next speaker. After the fourth section, I found myself using the term “mixed bag” for the third time; it was at that moment that I knew I had my title for this letter!

Of course, “mixed bag” is an overused and unoriginal cliché to describe a perspective that features both positive and negative elements. If we focus solely on the first half of the year, it is hard to find much good news at all between negative economic growth, historically high inflation, and hefty losses in both the equity and bond markets. Even the good news is rooted in how bad things are…after all, how much longer can inflation stay above 9%? Could the equity market REALLY drop another 20% the second half of the year? Alas, our “mixed bag” descriptor admittedly relies on the assumption that conditions should improve at least somewhat for the remainder of the year, though likely not enough to reverse the damage inflicted during the first half. On an absolute and relative basis, growth and return figures should be better, but it is naïve to think that all of the bad news is behind us.

In this edition:

  • Inflation expectations
  • Consumer and business sentiment
  • The S&P 500’s worst six-month start to a year since 1970
  • Recession probability
  • The Agg’s worst start to a year ever
  • Bonds go back to being bonds

Read > Halftime Market Outlook: A Mixed Bag

 

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.

2022 Halftime Market Insights Video

This video is a recording of a live webinar held July 20th by Marquette’s research team, featuring in-depth analysis of the first half of 2022 and risks and opportunities to monitor in the coming months.

Our Market Insights series examines the primary asset classes we cover for clients including the U.S. economy, fixed income, U.S. and non-U.S. equities, hedge funds, real estate, infrastructure, private equity, and private credit, with presentations by our research analysts and directors.

Sign up for research alerts to be notified when we publish new videos and invited to future webinars.
For more information, questions, or feedback, please send us an email.

Can Bond Investors Outsmart the Market?

While it is generally accepted that successfully and consistently timing the equity market is a loser’s bet, the same sentiment is not heard as often in the bond market. However, timing interest rates is just as difficult as equity markets and can lead to the same patterns of underperformance over multiple market cycles. Nonetheless, the recent rate volatility may be a temptation to shorten duration in anticipation of further rate rises. The following analysis examines why this strategy could be difficult to execute successfully, and why we recommend that clients stay the course and remain invested in line with their investment policies.

Read > Can Bond Investors Outsmart the Market?

 

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.