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In the Know: Getting Strategic with Fixed Income

This article was originally published on ETFTrends.com.

Investors are picking themselves up in 2019 after a tumultuous way to end 2018. The Dow Jones Industrial Average fell 5.6 percent, while the S&P 500 was down 6.2 percent and the Nasdaq Composite declined 4 percent.

2018 marked the worst year for stocks since 2008 and only the second year the Dow and S&P 500 fell in the past decade. In 2019, investors are no doubt reassessing their strategies for how to distribute their capital through the rest of the year.

In this latest "In The Know" update featuring market themes and opportunities, Samantha Azzarello, Global Market Strategist at JP Morgan ETFs, discussed opportunities investors can look to for guidance in 2019, particularly when it comes to fixed income.

As markets have cycled out of the growth and momentum-fueled investments of 2019, a move to more quality-oriented investments are in order. Identifying these quality-based investments, however, will require more due diligence.

“We’re at the beginning of late stages,” said Azzarello. “I think what that means is a lot more volatility. We maybe want to have a bias to quality. We want to be very selective because we think with the end in sight, there’s an element of protection to have in portfolios.”

“In equities, it means good quality balance sheets, strong management, the ability to pay out a dividend, everyone loves income,” added Azzarello.

Getting Strategic with Fixed Income

The end of 2018 also spurred a move to bonds as investors sought after safe-haven alternatives amid the volatility. One corner of the bond market that especially saw an influx of capital was short duration bonds.

While shorter durations still have a place in fixed income portfolios, Azzarello also feels more duration can help shore up portfolios--a plus during times of volatility.

“I think the appeal of short duration in 2018 is going to continue in 2019,” said Azzarello. “Being able to get a little bit of income on that short end of the curve—we still think that’s important. However, we’re also saying you need to have a little more duration in at least a part of the portfolio just to have a balance, just to have protection if volatility hits.

The default bond play to get broad-based exposure might be the  iShares Core US Aggregate Bond ETF (AGG) , which tracks the investment results of the Bloomberg Barclays U.S. Aggregate Bond Index. The AGG gives bond investors general exposure to the fixed income markets, but there are times when current market conditions warrant a deconstruction of the AGG to extract maximum investor benefit--one area Azzarello suggests is active fixed income.

“I think more active within fixed income is called for, and even just more granularity,” said Azzarello. “So, I agree the Barclays AGG used to be the be all end all for the fixed income market. Not anymore. We know we can do better than that, we can have a better duration profile, we can get a bit more income and just be a little bit susceptible to market moves if we're smarter with how we implement within fixed income.”

With that being said, as more investors begin to add fixed income to their portfolios, it will take more of a strategic bent. This is especially so since the Federal Reserve said during its fourth and final rate hike in December 2018 that it will do more reassessing, which could mean lesser rate hikes in store for 2019.

With the short-term strategy of lesser rate hikes in store, the long end of the curve, however, is much less clear. As such, investors will need more guidance for their fixed-income portfolios.

“Fixed income needs a little bit more finessing right now because the Fed is raising rates on the short end,” said Azzarello. “Yet, the long end is a little bit of a wild variable—rates have been going up, but also down in the 10-year yield so I think you need a little bit more finesse with your fixed income strategy.”

That strategic allocation into fixed-income means that investors should also look overseas for opportunities. While it’s tempting to simply allocate capital into the domestic bond markets, investors shouldn’t ignore the international credit markets, especially with countries like China becoming less stringent with respect to foreigners accessing their once hard-to-penetrate markets.

Overseas Opportunities for Fixed Income

Like sports, it can also be easy to cheer for the home team when it comes to making investments. In the U.S. bond markets, this would be akin to investors keeping their capital allocated domestically.

However, as the U.S. capital markets make their way out of the late cycle, it can be opportunities overseas that can be more attractive alternatives.

“So home bias within equities is something that's most investors are very aware of,” said Azzarello. “I don't think investors are as aware of their home bias within fixed income. And it's, it's pretty intense so most American investors, 93% of their fixed income is domestic US. We say you need to look outside for more income and more diversification. So look abroad.”

Certain areas overseas may be earlier in their market cycles compared to the U.S. so issues like rate risk are not yet a concern. Additionally, bond markets overseas could provide more competitive yields when compares to those of the U.S. where a credit risk in a late market cycle could pose a concern.

“U.S. fixed income markets did everything they needed to do as an investor and that’s just no longer the case,” Azzarello added. “ECB, Bank of Japan—no one is raising rates any time soon around the world so there’s still opportunities there. Then even credit within other parts of the globe look good as well.

To watch the entire latest "In the Know" show, visit: https://am.jpmorgan.com/us/en/asset-management/gim/adv/insights/etfs-in-the-know.

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