Bond market issues and potential solutions

 

There are many worries with regard to the bond market and some of the investments that are held by many investment firms. In spite of all the concern, bonds generally have performed well since the sell-off a little over a year ago and year to date are performing nicely with the 10-yr note down to approximately 2.40%.

 

Bond, ETFs and mutual funds with longer durations have performed better than those with low or zero duration generally speaking as yields have come down significantly.

 

That solid performance has led many to deem the current conditions as a bubble or at least possessing stretched valuations. This places many firms in a conundrum since many investment policies mandate that there must be some allocation to fixed income. There may be many questions and concerns at this time in the cycle.

 

Given our reading and market observance we have compiled a short list of issues that may resonate in part or fully with your firm as you contemplate your fixed income asset allocation.

 

  1. Interest rates are low and anticipated to rise. Many products’ durations are high and a rise in interest rates would likely lead to a loss in principal.

 

  1. Low to negative real yields persist globally. Where are there pockets of value if any across the global debt markets? Many ETFs do not possess the nimbleness to be able to take advantage of the few that may remain. Would it be prudent to seek an active manager to replace some ETF exposure?

 

  1. Uncertainty with regard to inflation rates and the effect on bond market performance is a real concern. Is it time to shift some money allocated to traditional bonds and move it to inflation indexed notes?

 

  1. Spreads over Treasuries are tight by historical standards in many bond classes. It has become more difficult to find value. Spreads in some areas may remain tight but could tighten further or if conditions deteriorate, they may widen. It is important to have a flexible manager who is able to navigate these spread sectors.

 

We suggest that your firm dedicate an entire series of investment committee meetings to address these difficult issues to determine if a change is warranted.

 

In that effort, Zenith is happy to extend its assistance in a few ways. First, we are able take the time to discuss the various markets across the global bond landscape to share our insight as it relates to valuation, risk, potential rewards and outlook.

 

We are also ready to take an objective look at your current holdings and let you know our unbiased thoughts. This would provide you with an outside view to help facilitate a robust discussion that would either lead to a renewed conviction in your holdings or it could begin a healthy process that uncovers additional managers or ETFs that better suit your firm’s risk tolerance.

 

Finally, we are ready to present those managers who we believe are best equipped to handle the difficult road ahead in the debt markets. We not only look at their historical metrics but we also look acutely into their process. This is important as only those fund managers with a broad mandate will be able to add value in our opinion over the next few years.

 

Let us know if we can help your firm sort through some or all of these issues with regard to the ever evolving and challenging bond market.

 

Sincerely,

 

Tom Koehler, CIO

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