He added there might also be opportunities for bond investors in the realm of credit upgrades, as last spring saw a large number of fallen angels, or companies downgraded from investment grade to high-yield territory, within a two-month period.
“Historically, upgrade trends don’t play out in two months, but two years,” Tannuzzo said. “The credit upgrades for companies who have managed their balance sheets well will come late this year or early 2022, and there may be some price appreciation there, but those will be the exceptions, not the rule.”
That means to achieve a real return from their fixed-income allocations, most investors will have to look for sectors and asset classes paying yields above the rate of inflation, but many of the asset class and sector plays available to bond investors in 2020 will no longer work in 2021.
For example, after the market declines at the height of the pandemic last spring, investment-grade credit became extremely attractive for a time but faded as the Federal Reserve became involved in the credit market, said Tannuzzo. Then, investor attention moved to high-yield bonds last summer, which similarly became less attractive as the year progressed and investor attention moved to emerging-market bonds.
“Now as we sit here today, I don’t think there’s a single sector that stands out as cheaper than the rest because liquidity risk premia have condensed,” he said. “I do think there’s some opportunity in a broadly recovering economic environment. You want exposure to credit-sensitive assets to help generate income, but it should be in a more diversified, risk-balanced way. Portfolio construction plays a huge role now.”
It also means that the cost paid for fixed-income funds has become even more critical to the performance of investment portfolios, Tannuzzo said, because other variables impacted the net yield to an end client—such as taxes and Treasury yields—are unlikely to change much over the course of the year.
“A fixed fee or expense ratio is starting to take a much larger proportion of my after-tax income,” he said. “Solutions that are cost-effective have an even more significant impact today than they would in a high-yield, high-spread, low-tax environment.”
That’s where DIAL and MUST come in.
“Both operate on a similar principle that we can generate more yield for a portfolio than a traditional index by expanding the opportunity set,” said Tannuzzo. Managers of both ETFs try to manage tail risk by selecting quality securities and keeping their focus on the more liquid portions of the fixed-income universe.
The $925 million DIAL ETF yields 2.62% and targets six sectors: U.S. Treasurys; U.S. agency mortgage-backed securities; U.S. corporate investment-grade bonds; U.S. high-yield bonds; developed country sovereign bonds ex-U.S. Treasurys and emerging markets sovereign debt. Over three years ending on Jan. 31, this ETF has offered investors 6.62% returns based on net-asset value, according to Columbia Threadneedle. It carries a 0.28% expense ratio.
The $75 million MUST ETF yields 2.18% and targets five segments of the municipal markets: Municipal core general obligations; high-quality revenue; core revenue; healthcare and high-yield. Over three years ending on Jan. 31, the ETF has offered investors 5% returns based on net-asset value, according to Columbia Threadneedle. It carries a 0.23% expense ratio.