Views From The Experts

 

 Matthew Freund
Chief Investment Officer,
USAA Mutual Funds USAA Investments

 

 

 

 

 

Four reasons advisors Should Consider tactically adding to their taxable Bond weighting

 

Diversiincome and portfolio stability during chal-lenging markets—these are all key reasons why investors have a strategic allocation to fixed income. Tactically or dynamically adjusting that allocation up or down can also make sense as an opportunistic response to changing market conditions.
 

Here are four reasons we at USAA Investments believe advisors should actually consider tactically adding to their taxable bond weight-ing in the near-term:

 

1. Interest rates are Likely to Stay Low for the next Several Years,  Mitigating duration risk:
Infrastructure spending may be going up and the Federal Reserve may want to normalize interest rates, but we don’t see much room for acting on that desire. Frustratingly slow GDP growth and scant inat home takes away the urgency and, given the size of the stimulus under way in other major economies, any move could add un-wanted strength to the U.S. dollar. Although the Fed may hike short-term rates in December, we don’t believe long-term rates will bottom until the next recession.

 

2. Bond Prices have reasonable Support:
Europe’s and Japan’s multi-trillion-dollar experiment with negative interest rates is driving yield-desperate investors toward non-traditional asset classes including stocks and corporate bonds. As those strug-gling economies expand their commitment to QE and other monetary efforts to try to spur growth, we foresee even more overseas investors crossing the oceans in search of return. This growing demand stands to be supportive of U.S. bond prices.

 

3. there’s a Better Opportunity in Corporate Credit vis-à-vis treasuries, Based on relative Valuations:
Credit has performed well in this environment, and we believe it can continue to do so. We see an opportunity in certain corporate BBBs where bond yields are currently about 175 bps above Treasuries (on average). With U.S. equity valuations well above their historic average, we are also increasing our allocation to high yield to gain equity-like exposure at what we believe to be lower relative risk. Investors would likely get less upside if equities continue to run, but they may be better protected if volatility picks up.

 

4. It’s about the “Income” in “Fixed Income,” but Selectivity  Matters:
Most of the long-term returns from bonds come from income, but getting appropriately compensated for credit risk is getting harder. We believe compelling yields can be found in certain investment grade corporate and high yield bonds, even though some yields are down from their peaks. Selectivity is key to mitigating credit risk presented by speciissuers and broader industries. Default rates overall are still fairly low, but they are ris-ing in some sectors, notably energy. This trend presents an oppor-tunity for those who can tolerate more portfolio risk. A widening of credit spreads in corporate and high yield bonds can cause vol-atility, but for long-term investors, credit losses aren’t permanent unless there is a default—this is why a seasoned credit research team is crucial. One caveat—we’re not sure the current market is pricing in the possibility of an economic downturn, which would hurt high yield in the short run, but may potentially provide a buying opportunity for long-term investors.
 

Income-oriented and tax-sensitive investors may also want to look at municipal bonds. Demand well in excess of supply is supporting prices across the quality spectrum, and while this trend is suppressing yields, the tax-advantaged income surpass-es comparable Treasuries at a very low default risk. Should rates rise, munis may be even more attractive, as they have tended to outperform Treasuries due to less interest-rate sensitivity.


The fixed income securities are subject to price volatility and a number of risks, including interest rate risk. Interest rates and bond prices move in opposite directions so that as interest rates rise, bond prices usually fall, and vice versa. Interest rates are currently at historically low levels. Fixed income securities also carry other risks, such as ination risk, liquidity risk, call risk, and credit and default risks.  Lower-quality xed income securities involve greater risk of default or price changes. Securities of non-U.S. issuers generally involve greater risks than U.S. investments, and can decline signiy in response to adverse issuer, political, regulatory, market, and economic risks. Fixed-income securi-ties sold or redeemed prior to maturity may be subject to loss.

This material is provided for informational purposes only by USAA Asset Management Company (AMCO) and/or USAA Investment Man-agement Company (IMCO), both registered investment advisers. The material is not investment advice and is not a recommendation, an offer, or a solicitation of an offer, to buy or sell any security, strategy, or investment product. The views and opinions expressed in the material solely reect the judgment of the authors, but not necessarily those of AMCO, IMCO or any ates as of the date provided and are subject to change at any time. All information and data presented herein has been obtained from sources believed to be reliable and is believed to be accurate as of the time presented, but AMCO/IMCO do not guarantee its accuracy. The information presented should not be regarded as a complete analysis of the subjects discussed. Any past results provided do not predict or indicate future performance, which may be negative. No part of this mate-rial may be reproduced in any form, or referred to in any other publication, without express written permission of AMCO/IMCO and USAA.

Investments provided by USAA Investment Management Company and USAA Financial Advisors Inc., both registered broker dealers, and aliates.      235811-1016


 

USAA was founded in 1922 by 25 U.S. Army officers in San Antonio, Texas. We have been in the investment business for over 45 years. With over 11 million members, USAA is one of the leading financial services providers to the military and veteran community and their families. At USAA, our disciplined approach to managing money stems from our military values of service, loyalty, honesty and integrity. It’s a commitment we share with those we serve. USAA Investments has over $67.1 billion in assets under management as of June 30, 2016.