Fran Rodilosso, Head of Fixed Income ETF Portfolio Management, CFA
June 14, 2019
The U.S. Federal Reserve’s (Feds) change in outlook surprised the market earlier this year. We are now looking at an easing monetary policy—perhaps an interest rate cut, rather than hikes, in 2019—and the prospect of the Fed shrinking its balance sheet far less than the market previously expected.
The greater liquidity in the market and low base rates have already had two significant effects, in our view: 1) markets have been “risk on” again, combined with some hope for the continued extension of recent economic expansion; and 2) within fixed income in general, people are having to look for new sources of yield as yields on U.S. Treasuries have come back down.
The question is, therefore, how to achieve portfolio diversification and obtain greater income than that generated by Treasuries. Opportunities we see include high yield, emerging markets debt, or tax-advantaged solutions. Equity income, too, is now back on people’s radar screens. And preferred shares also provide an option.
What we particularly like about DURA’s underlying index is that Morningstar’s equity research team looks not only at the long-term durability of dividend payments, but also at both the attractiveness of constituent companies’ valuations and their financial health.
Another approach could be to look at preferred shares, which lie between bonds and equity in a company’s capital structure. While some preferred equity may have either no, or a sub-investment grade rating, the majority of preferred issuers are rated investment grade with regard to their senior debt. Yet, because of their place within a company’s capital structure and what tends to be longer duration, preferreds may provide yields equivalent to those of high-yield bonds. The VanEck Vectors® Preferred Securities ex Financials ETF (PFXF®) provides investors with access to this space. The fund tracks the overall performance of U.S.-listed preferred securities excluding those with a financial sector classification.
We are often asked about the size of the investment grade U.S. corporate bond market and particularly the BBB universe. With that segment of the investment grade market now at around $3 trillion, will there be more bonds than the high-yield universe can absorb if (or when) the credit cycle ends, the economy slows down, and there is a wave of downgrades? Our short answer is: “Probably not!” Although we do see there being more fallen angel bonds, or high-yield corporate bonds that were originally issued as investment grade bonds, we believe that this will create some further opportunities in high-yield bonds. Investors can gain exposure to this space through the VanEck Vectors® Fallen Angel High Yield Bond ETF (ANGL®).
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