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3 Fixed Income Areas Of Value

Cinthia Murphy

Investors looking for value in fixed income relative to a broad benchmark such as the Barclays Aggregate should take a closer look at three pockets of the market—high yield bonds, bank loans and asset-backed investment grade securities—according to Guggenheim.

In its latest quarterly market outlook, Guggenheim’s team of investment managers said that the U.S. economy isn’t going to see a recession this year, or next, and oil prices will stabilize around $40 a barrel by year-end.

More specifically, the team led by Global Chief Investment Officer Scott Minerd, said that oil will remain a key player in market volatility, but downgrades and defaults in energy should be over by the end of the first half of the year. The second half of 2016 should bring stability to oil prices, and that will open up opportunities in the pockets of fixed income such as high yield.

With that macro picture as a backdrop, here are Guggenheim’s picks for relative value:

High-Yield Bonds

High-yield bonds have been largely out of favor as investors braced for a pickup in defaults associated with the slump in oil prices, and its impact on the energy sector. But Guggenheim argues that high-yield bonds offer attractive yields, and the recent beating of the segment was overdone.

“The high yield bond market has been unfairly punished due to commodity weakness and the resulting spillover,” the company said in its latest market outlook. “Yields in many industries are 1.5-2% higher than they were when oil prices began to decline in mid-2014, despite stable fundamentals, and should appeal to clients with higher risk tolerance.”

For ETF investors, the biggest ETFs in this segment are the iShares iBoxx $ High Yield Corporate Bond (HYG | B-68) with $14.6 billion in assets, and average daily trading volume of more than $1.2 billion; and the $11.75 billion SPDR iBoxx $ High Yield Bond (JNK | C-68), trading nearly $500 million on average a day.

Both funds track market-weighted indexes of high-yield corporate debt, and as of March 17, HYG’s 30-day yield sat at 7.15%, while JNK is shelling out 30-day yields of 7.21%.

After tallying losses of more than 5% in 2015, these ETFs seem to have found some sort of a bottom in recent weeks, as the chart below shows:

Bank Loans

Bank loans have also fallen victim to the oil market weakness in the past several months, Guggenheim said in its market outlook, but “low rate sensitivity, attractive yields, [low] exposure to commodity sectors, a higher position in the capital structure than bonds, and floating-rate coupons” should offer investors enough incentive for the risk it poses.

For ETF investors, the most popular bank loan ETF is the PowerShares Senior Loan (BKLN | C), with $3.8 billion in assets under management, and daily trading volume averaging $58 million. The fund tracks a market-value-weighted index of senior loans issued by banks to corporations, and offers a liquid way to earn higher yield with less interest-rate risk, but significantly higher credit risk because the majority of the fund is below investment grade.

Another fund in this segment is the SPDR Blackstone / GSO Senior Loan (SRLN | C). The $784 million actively managed ETF invests in below-investment-grade, floating-rate senior secured debt of U.S. and non-U.S. corporations.

Since mid-Feb, these strategies have been gaining ground, as the chart the below shows:

Non-Agency Asset-Backed Securities

“Non-agency [residential mortgage-backed securities] RMBS generally offer 3.5-5% yields that are floating rate, senior and amortizing, and reflect conservative default and recovery assumptions,” Guggenheim said.

Meanwhile, investment-grade asset-backed securities (ABS) fit the bill for investors “with rating restrictions” and those looking for short interest-rate duration, the company said. Some of highest-graded of these securities are known for showing strong credit performance, with negligible defaults and principal losses in over a decade.

In the ETF space, there seems to be no easy way to access this pocket of fixed income. Exposure to these types of assets is often found within broader strategies such as the SPDR DoubleLine Total Return Tactical ETF (TOTL | C), which allocates roughly half of the portfolio to mortgage-backed securities—or roughly twice the allocation of the Barclays Aggregate. And these securities are agency-backed.

There’s also the iShares CMBS ETF (CMBS | B-98), but the fund tracks an index of commercial—rather than residential—investment-grade mortgage-backed securities with an expected life of at least one year. The 4-year-old fund has $163 million in assets.

Since the beginning of the year, both these ETFs have been delivering positive returns, as the chart below shows:

Charts courtesy of StockCharts.com

Contact Cinthia Murphy at cmurphy@etf.com.


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