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Look to Active Bond ETFs in a Changing Fixed-Income Environment

This article was originally published on ETFTrends.com.

As the new year fast approaches, bond investors should consider ETF strategies with attractive risk-adjusted returns and stability within a broad investment portfolio.

On the recent webcast (available On Demand for CE Credit), Fixed Income Investing in Volatile Markets, David Braun, Head of U.S. Financial Institutions Portfolio Management at PIMCO, warned that while PIMCO maintains a positive cycle outlook for 2019, growth will be slowing ahead. He also pointed to near-term swing factors that could affect global growth, such as the de-escalation in global trade tensions or potential worsening in trade frictions, along with increased business investment in the U.S. Despite the aging bull market, U.S. fundamentals remain solid with unemployment rates near half-century lows, wage growth, steady inflation and a Federal Reserve that has been acting accordingly.

With an aging economy, investors will expect rising interest rates and the potential end to the decades-long bull run in the bond market. However, Braun argued that rates could likely remain low in a so-called New Neutral world where an aging population, weak productivity growth, debt overhang and muted inflation contribute to slowing growth, which would result in a lower interest rate outlook - PIMCO has called for range bound rates.

"Unless you think we’re going back to significantly higher growth or outsized inflation, we think rates will be range bound," Braun said.

Moreover, Braun outlined the potential benefits of sticking with a fixed-income position for their yield benefits, instead of ditching the asset class for cash. Looking at the past 20-year risk versus return characteristics of various assets, a 60% stock and 40% bond portfolio would have still generated improved returns with the same amount of risk as a portfolio of 60% stocks and 40% cash.

Don Suskind, Head of ETF Strategy at PIMCO, also argued that investors may be better off with an active manager at the helm when gaining exposure to the fixed-income market. Bond index-based ETFs generally follow a sampling methodology that pick out some debt securities to gain an overall picture of their intended market and will also follow a capitalize-weighted methodology that overweights more indebted issuers. Alternatively, according to Morningstar data, about 80% of active bond managers have outperformed their benchmarks across a range of popular categories, like intermediate-term bonds, short-term bonds, world bonds and multi-sector bonds over the past 10 year period. In contrast, 30% of actively managed large-cap blend stock funds have beat their benchmarks.

An active manager could add value to a bond fund and are more quick to react to market changes. In comparison, the widely observed Bloomberg Barclays U.S. Aggregate Index has seen duration or rate risk increase 30% since 2007 and yields decline about 30% over the same period. Basically, passive bond investors are exposed to greater rate risk and getting paid less for that higher risk.

Investors can look to actively managed bond ETFs in this changing market environment. For example, the PIMCO Active Bond ETF (BOND) is one of the largest actively managed exchange traded funds and the management style could serve fixed income investors well as the Federal Reserve continues boosting interest rates. BOND shows a 5.65 year effective duration and a 3.72% 30-day SEC yield.

PIMCO’s active strategies performed well when rates increased. Looking at returns since the peak of the 10-year rate in July 2016, BOND exhibited a 1.47% total cumulative return, compared to the -1.49% dip in the Agg.

Beyond a fixed-income core holding like BOND, fixed-income investors can also supplement with less rate sensitive strategies like the PIMCO Low Duration Active ETF (LDUR) . LDUR has a short 1.06 year duration, so a 1% rise in interest rates would only translate to about a minimal 1.06% decline in the fund’s price, and it shows a 3.39% 30-day SEC yield.

Additionally, the PIMCO Enhanced Short Maturity Active ETF (MINT) can provide additional yield beyond cash. MINT is meant to be used as an incremental step outside of the money market funds. Investors would use the active ETF for capital preservation or to take a defensive view on the market. MINT shows a 0.31 year duration and a 2.67% 30-day SEC yield.

Financial advisors who are interested in learning more about fixed-income investments can watch the webcast here on demand.