Sinking Floaters
Still, the jury’s out on whether the majority of active bond strategies will continue to outperform index funds. For most of the year, MINT was losing out to the largest funds tracking floating rate notes and senior loans, which had been two of the best-performing fixed-income categories in 2018.
Expectations for slower interest rate increases has added pressure to the 10-year Treasury yield, pushing holders out of funds like the iShares Floating Rate Bond ETF, or FLOT. Investors have yanked more than $853 million from FLOT in December, putting it on pace for a record month of outflows and the first pullback since October 2016.
The bloodbath for senior loan ETFs has been even worse, despite outperforming virtually every other bond category for much of the year. Senior loan funds might get the spotlight this coming year by stepping in as substitutes for high-yield exposure, said Matthew Bartolini, head of SPDR Americas research at State Street Global Advisors. Senior loans have a higher position than junk bonds in a company’s capital structure and therefore can help mitigate some of the downside risk as cracks deepen in the credit market, he said.
“For credit investors who feel like moving up in quality while still maintaining a high coupon, it would be within senior loans,” Bartolini said.
Emerging Markets
Looking outside of the U.S., the Fed’s rate path looks particularly good for at least one category: emerging markets. Despite big declines in performance in 2018, cash has continued to flow into local currency emerging-market debt funds. Investors have added close to $630 million to the VanEck Vectors J.P. Morgan EM Local Currency Bond ETF, or EMLC, this year, which has slumped around 13 percent in the past 12 months.
Rising rates and a weakening U.S. dollar should hurt dollar-denominated credit, leading to a preference for local currency bonds, which may emerge as shining stars under this scenario, WallachBeth’s Bajaj said. After all, a wager abroad might be safer than a bet at home.
“There is a lot of uncertainty,” Bajaj said. “Investors who are willing to park cash in these products get a guaranteed yield instead of risking getting whipsawed again.”
This article was provided by Bloomberg News.