Anyone looking for a fresh perspective from Federal Reserve (Fed) Chairman Jerome Powell last week was sorely disappointed. During his semiannual monetary policy testimony to Congress, Powell essentially reiterated his stance that, yes, the economy is in a solid recovery, but no, the recent spike in inflation is only “transitory.” Sound familiar? Thought so. In fact, he went so far as to say that the bar for a potential exit strategy, “substantial further progress,” was still a ways off.
So, where does that leave fixed income investors? I find myself returning to this question rather frequently in various discussions. Despite Chair Powell’s unchanged stance, I continue to focus on two overarching themes for the second half of this year and into 2022: keeping duration short and credit over rates. Against this backdrop, I thought it would be a good exercise to highlight how investors can put these two themes to work.
First up, on the short duration theme, investors may wish to consider the WisdomTree Yield Enhanced U.S. Short-Term Aggregate Bond Fund (SHAG). This vehicle is the short duration version of our core fixed income flagship WisdomTree Yield Enhanced U.S. Aggregate Bond Fund (AGGY), which we have written about many times.
Following the same strategy as AGGY, SHAG reweights the sectors of the one- to five-year segment of the Short Agg Composite while adhering to two main guardrails: the weight of major and minor sectors cannot deviate by more than 30% from their weights in the Short Agg Composite and duration generally will not be more than half a year of this benchmark.
This approach not only focuses on mitigating interest rate risk, but it seeks to boost yield. In addition, SHAG carries a five-star rating from Morningstar1.
For the second theme, I’d like to highlight the WisdomTree U.S. High Yield Corporate Bond Fund (WFHY). Investing in high yield can carry the potential for an elevated risk profile compared with the investment-grade sector. The approach behind WFHY is to screen for quality to potentially mitigate the possibility of future default risk. This strategy focuses on only public issuers domiciled in the U.S. and eliminates those with a negative cash flow. We then reweight this remaining universe to tilt weights toward bonds with more favorable income characteristics.
From an investment perspective, WFHY can serve as a quality screened income sleeve in a core-plus bond portfolio. Also, WFHY has a four-star Morningstar rating, with five stars over the last three-year period2.
With the challenges impacting the current fixed income setting, investors have faced some difficult choices. In my opinion, SHAG and WFHY could help investors navigate the uncharted policy waters that may lie ahead.
1Based on risk adjusted returns as of 6/30/2021 out of 524 funds for the Short-Term Bond fund category for the 3 year period.
2Based on risk adjusted returns as of 6/30/2021 out of 634 and 556 funds for the High Yield Bond funds category for the 3 and 5 year periods, respectively.
Originally Posted on July 21, 2021 – Aligning the Stars in Fixed Income
Important Risks Related to this Article
There are risks associated with investing, including possible loss of principal. Fixed income investments are subject to interest rate risk; their value will normally decline as interest rates rise. Fixed income investments are also subject to credit risk, the risk that the issuer of a bond will fail to pay interest and principal in a timely manner or that negative perceptions of the issuer’s ability to make such payments will cause the price of that bond to decline. Investing in mortgage- and asset-backed securities involves interest rate, credit, valuation, extension and liquidity risks and the risk that payments on the underlying assets are delayed, prepaid, subordinated or defaulted on. Due to the investment strategy of the Fund, it may make higher capital gain distributions than other ETFs. High-yield or “junk” bonds have lower credit ratings and involve a greater risk to principal. Fixed income investments are also subject to credit risk, the risk that the issuer of a bond will fail to pay interest and principal in a timely manner or that negative perceptions of the issuer’s ability to make such payments will cause the price of that bond to decline. While the Fund attempts to limit credit and counterparty exposure, the value of an investment in the Fund may change quickly and without warning in response to issuer or counterparty defaults and changes in the credit ratings of the Fund’s portfolio investments.
Please read each Fund’s prospectus for specific details regarding the Fund’s risk profile.
Morningstar, Inc., 2021. All rights reserved. The information contained herein: (1) is proprietary to Morningstar and/or its content providers; (2) may not be copied or distributed; and (3) is not warranted to be accurate, complete or timely. Neither Morningstar nor its content providers are responsible for any damages or losses arising from any use of this information. Past performance, rankings and ratings are no guarantee of future results. The % of Peer Group Beaten is the fund’s total-return percentile rank compared to all funds within the same Morningstar Category and is subject to change each month. Regarding ranking of funds, 1 = Best.
For each fund with at least a three-year history, Morningstar calculates a Morningstar RatingTM metric each month by subtracting the return on a 90-day U.S. Treasury Bill from the Fund’s load-adjusted return for the same period and then adjusting this excess return for risk. Five stars are assigned to the top 10%, four stars to the next 22.5%, three stars to the next 35%, two stars to the next 22.5% and one star to the bottom 10%. The Overall Morningstar Rating for a fund is derived from a weighted average of the performance figures associated with its three-, five- and 10-year (if applicable) Morningstar Rating metrics. The WisdomTree Yield Enhanced U.S. Short-Term Aggregate Bond Fund was rated against the following numbers of U.S.-domiciled short-term bond funds over the following periods: 524 funds in the last three years. With respect to these short-term bond funds, the WisdomTree Yield Enhanced U.S. Short-Term Aggregate Bond Fund received a Morningstar Rating of five stars the three periods. Past performance is no guarantee of future results.
For each fund with at least a three-year history, Morningstar calculates a Morningstar Rating metric each month by subtracting the return on a 90-day U.S. Treasury Bill from the Fund’s load-adjusted return for the same period and then adjusting this excess return for risk. Five stars are assigned to the top 10%, four stars to the next 22.5%, three stars to the next 35%, two stars to the next 22.5% and one star to the bottom 10%. The Overall Morningstar Rating for a fund is derived from a weighted average of the performance figures associated with its three-, five- and 10-year (if applicable) Morningstar Rating metrics. The WisdomTree U.S. High Yield Corporate Bond Fund was rated against the following numbers of U.S.-domiciled high-yield bond funds over the following periods: 634 funds in the last three years and 556 funds in the last five years. With respect to these high-yield bond funds, The WisdomTree U.S. High Yield Corporate Bond Fund received a Morningstar Rating of five stars and four stars for the three- and five-year periods, respectively. Past performance is no guarantee of future results.
Disclosure: WisdomTree US
Investors should carefully consider the investment objectives, risks, charges and expenses of the Funds before investing. U.S. investors only: To obtain a prospectus containing this and other important information, please call 866.909.WISE (9473) or click here to view or download a prospectus online. Read the prospectus carefully before you invest. There are risks involved with investing, including the possible loss of principal. Past performance does not guarantee future results.
You cannot invest directly in an index.
Foreign investing involves currency, political and economic risk. Funds focusing on a single country, sector and/or funds that emphasize investments in smaller companies may experience greater price volatility. Investments in emerging markets, real estate, currency, fixed income and alternative investments include additional risks. Due to the investment strategy of certain Funds, they may make higher capital gain distributions than other ETFs. Please see prospectus for discussion of risks.
WisdomTree Funds are distributed by Foreside Fund Services, LLC, in the U.S. only.
Disclosure: Interactive Brokers
Information posted on IBKR Traders’ Insight that is provided by third-parties and not by Interactive Brokers does NOT constitute a recommendation by Interactive Brokers that you should contract for the services of that third party. Third-party participants who contribute to IBKR Traders’ Insight are independent of Interactive Brokers and Interactive Brokers does not make any representations or warranties concerning the services offered, their past or future performance, or the accuracy of the information provided by the third party. Past performance is no guarantee of future results.
This material is from WisdomTree US and is being posted with permission from WisdomTree US. The views expressed in this material are solely those of the author and/or WisdomTree US and IBKR is not endorsing or recommending any investment or trading discussed in the material. This material is not and should not be construed as an offer to sell or the solicitation of an offer to buy any security. To the extent that this material discusses general market activity, industry or sector trends or other broad based economic or political conditions, it should not be construed as research or investment advice. To the extent that it includes references to specific securities, commodities, currencies, or other instruments, those references do not constitute a recommendation to buy, sell or hold such security. This material does not and is not intended to take into account the particular financial conditions, investment objectives or requirements of individual customers. Before acting on this material, you should consider whether it is suitable for your particular circumstances and, as necessary, seek professional advice.
In accordance with EU regulation: The statements in this document shall not be considered as an objective or independent explanation of the matters. Please note that this document (a) has not been prepared in accordance with legal requirements designed to promote the independence of investment research, and (b) is not subject to any prohibition on dealing ahead of the dissemination or publication of investment research.