Today’s Historic Opportunity in Actively Managed Bonds
Text on screen: PIMCO
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Text on screen: David L. Braun, Head of US Financial Institutions
2024 is shaping up to be an interesting year.
Our outlook is that growth is going to slow materially from 2023 as the fiscal stimulus from Covid has largely been spent down.
Image on screen: The Federal Reserve building, gas pump filling up, grocery store aisles
As for inflation, we expect inflation to continue to grind down to the Fed's targets over the coming couple of years. And that sets the stage for the Fed to begin to normalize interest rates.
We think two things are important. First, at these starting yields, we think it's a wonderful opportunity for investors to engage in the bond market.
Many investors have sat on the sidelines parked in cash for the past three to four years.
Text on screen: TITLE – Today yields are at a much stronger starting point
Image on screen: A bar chart and table show yields as of 29 February 2024 versus those from 31 December 2021 for eight fixed-income classes. Six of the eight asset classes show yields two to three times higher than those of three years ago, while two others are significantly higher. The first three pairs of bars are as follows: Agency MBS yield to worst in February 2024 is at 5.2%, up from 1.7% three years earlier; securitized credit is at 5.6%, up from 1.9%, and core is at 4.9%, up from 1.7%. Yields for investment grade credit are at 5.3%, up from 2.3%; and high-yield credit at 7.1%, up from 4.1%. Yield for emerging markets is at 6.5%, up from 4.4%. The final two pairs of bars, show municipal yields at 5.8%, up from 1.8%, and high-yield munis at 9.2%, up from 4.6%.
The yields we're looking at today are the most attractive they've been in perhaps 15 to 20 years.
For instance, if you look at core and core plus bond funds, today's starting yields are in the five-point half to six point half percent range. And high-quality multi-sector credit funds are closer to 7%. Those yields are not only attractive on an absolute basis, but we believe they're attractive versus other high-risk assets like equities. And earning that yield on these funds is just the start of the story.
There's an opportunity for capital appreciation.
Eventually at some point over the horizon, as inflation comes down, the Fed will normalize interest rate policy. And you'll not only earn that yield, but you're likely to get capital appreciation from the duration you've added and the roll down of the curve.
Second, how investors access the bond market is important. While in the equity market, passive indexing may work, bonds are different.
Text on screen: TITLE - Active bond managers have a solid track record
Image on screen: The graphic presents a bar chart titled "Percentage of active funds within each category that outperformed the passive median fund (10-year)." This visual data, taken from Morningstar Direct as of 31 December 2023, compares the performance of active fund managers to their passive counterparts across various investment categories over a decade. The chart is divided into Morningstar Fixed Income Active Management categories (displayed in blue) and Morningstar Equity Active Management categories (shown in green).
The data depicted in the graphic shows that a higher percentage of active bond funds outperform their passive peers, especially in the categories of High Yield Bond (with 80% of active funds outperforming) and Intermediate Core & Core-Plus (with 78% of active funds outperforming). The equity categories show a more moderate outperformance, with the Foreign Large Blend category performing best, at a rate of 52% of active funds outperforming.
In active equity funds, history shows that only about 30% of managers beat their passive peers net a fee. Whereas, Core and Core plus bond managers in the active space, roughly 80% beat their passive pair net a fee.
In the economic environment we're in right now and likely to be in for the next couple of years, we believe uncertainty, volatility and dispersion create a potentially attractive environment for the active bond manager who can be flexible and nimble in their portfolio management strategy, in their pursuit of alpha.
Text on screen: TITLE – Key terms to know:, BULLETS – Alpha: Referred to as the excess return of an investment, it gauges the performance of an investment relative to a market index or benchmark, Yield: The annual income (percentage) that an investor earns on an investment. The interest rate is the percentage charged by a lender for a loan. The yield on new bonds reflects interest rates at the time they are issued, Duration: The difference in time between the issue date for a bond and its maturity date. Money today is often not worth the same as in the future, though, so yields tend to be higher for longer duration bonds, Roll-down the curve: A bond trading strategy designed to maximize a bond’s overall yield by selling a bond as it approaches its maturity date.
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Disclosure
Investing in the bond market is subject to risks, including market, interest rate, issuer, credit, inflation risk, and liquidity risk. The value of most bonds and bond strategies are impacted by changes in interest rates. Bonds and bond strategies with longer durations tend to be more sensitive and volatile than those with shorter durations; bond prices generally fall as interest rates rise, and low interest rate environments increase this risk. Reductions in bond counterparty capacity may contribute to decreased market liquidity and increased price volatility. Bond investments may be worth more or less than the original cost when redeemed. Management risk is the risk that the investment techniques and risk analyses applied by an investment manager will not produce the desired results, and that certain policies or developments may affect the investment techniques available to the manager in connection with managing the strategy.
It is not possible to invest directly in a Morningstar category.
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Statements concerning financial market trends or portfolio strategies are based on current market conditions, which will fluctuate. There is no guarantee that these investment strategies will work under all market conditions or are appropriate for all investors and each investor should evaluate their ability to invest for the long term, especially during periods of downturn in the market. Outlook and strategies are subject to change without notice.
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