Opposites attract: Market outlook favours barbell approach…
Fran Rodilosso, CFA, Head of Fixed Income ETF Portfolio Management at VanEck
Our outlook for 2018 is characterised by the continued normalisation of interest rates in both the U.S. and Europe, and the U.S. Federal Reserve has already signalled more aggressive rate hikes to come. This environment favours reduced exposure to developed markets rates, which are still low but rising, and reducing duration. We feel that combining emerging markets local currency bonds with floating rate investment grade bonds can allow investors to position their fixed income portfolios for this current environment.
Unlike a traditional barbell which is based on maturity, this approach is primarily risk-based. It combines the diversification and yield potential of emerging markets bonds with the relative safety of U.S. dollar denominated investment grade corporate debt that also has a duration of nearly zero. Although these two asset classes are divergent in many ways, they share a common trait that is crucial in today’s environment: low or negative return correlation to U.S. treasury bonds.
Over the past year, the barbell portfolio would have performed similarly to a portfolio that used traditional fixed rate corporate bonds for its corporate exposure on an absolute basis and outperformed on a risk-adjusted basis. Although there is a give-up in yield, returns benefitted from the lower duration.
A barbell portfolio for the current environment
As of March 31, 2018
Source: J.P. Morgan, MVIS, ICE Data Indices, LLC and Morningstar, as of 3/31/2018. EM Local Bonds is represented by the J.P. Morgan GBI-EM Global Core Index. US IG Floating Rate is represented by the MVIS® US Investment Grade Floating Rate Index. US IG Fixed Rate Corporate Bonds is represented by the ICE BofAML US Corporate Index. Index returns are not representative of fund returns. Past performance is no guarantee of future results. Indices are unmanaged and are not securities in which an investment can be made.
In the current environment, we continue to favour the barbell approach. In addition to being better positioned against rising interest rates in the U.S., this portfolio may benefit from other global tailwinds. For example, although credit spreads are tight relative to historical averages, they may be justified given the current benign environment, and we expect positive fundamentals to remain supportive of U.S. credit.