How To Navigate An Increasingly Volatile Fixed Income Environment

May 12, 2017 7:05am NYSE:EMB

yield-down

From BlackRock: Fixed income investing today is very different from several years ago, but this doesn’t mean there aren’t opportunities for generating returns. Rick Rieder explains.


Fixed income investing today is very different from two or even three years ago. Then, we were in a U.S. economy with about 1% percent inflation and the potential risk of deflation. Now the U.S. is nearing a 2% inflation rate with the risk that more fiscal policy or some pullback of monetary policy could cause inflation to be a bit less, or a bit more, than 2%. Today’s much more uncertain inflationary dynamic means it’s more difficult to know where interest rates are heading than it was in the recent past. The fixed income market is also more volatile now than previously.

In this market environment it may be harder to know where to take interest rate exposure, but generating fixed income returns is still possible. Investors just have to think more carefully about where they make their allocations, taking into account relative values and risk around the world, around the capital stack, and across asset classes. Diligent research and analysis are critical to properly adding diversification and managing risks in portfolios. Against this backdrop, I see a number of potential investing opportunities, as I share in a recent Q&A piece on “Creating durable fixed income portfolios for an evolving market.”

Emerging markets

I see interesting opportunities for taking credit risk in selected emerging markets, particularly in markets such as Brazil and Mexico, where rates could come down. Compared to 20 years ago—or even just 10 years ago—emerging markets are in much better shape. Their reserves are higher, their leverage is lower, and they are relatively cheap compared to other parts of the world. Monetary policy has pushed rates in Europe to extremely low levels, which has pulled down global interest rates to distorted levels. But emerging markets have actually not been tethered to European rates.

Securitized assets

High-cash flow securitized assets markets present attractive opportunities to generate income, in my view. Technicals in the asset-backed market have been strong and fundamentals have been improving, particularly in areas like housing and commercial real estate. I believe investors can potentially build a durable portfolio with core foundations centered around assets with strong technicals, fundamentals, and cash flows, such as securitized assets, while also taking some credit risk where it looks intriguing, such as in select emerging markets.

Research and analytics, however, are key to generating returns within fixed income portfolios. Take the securitized market. This asset class is spread across a large number of securities, like the corporate bond market, though there are a number of risk factors that are unique to the sector. An investor needs to consider prepayment risk, underlying collateral performance, and a number of other risks when investing in this space. Furthermore, there are a wide range of collateral types within each securitized asset market. For example, the asset-back securities market includes sectors like credit card receivables and car loans, but it has also financed less traditional assets, such as concert tours. As with corporate bonds, the securitized market is far from simple, and mastery of it through a combination of expertise, rigorous inquiry, and analysis can potentially open up plentiful opportunities.

Bottom line

If your research is right, and you’re doing research around the world—looking at a Malaysian health care company, looking at UK mortgages—and you’re putting all those pieces together, analyzing their convexity, analyzing the analytics, optimizing the portfolio, assessing risk, and then using your technology and stress testing—that’s the recipe for success. Read more about my perspective on fixed income investing today in the full Q&A.

The iShares JPMorgan USD Emerging Market Bond Fund ETF (NYSE:EMB) was unchanged in premarket trading Friday. Year-to-date, EMB has gained 3.95%, versus a 7.09% rise in the benchmark S&P 500 index during the same period.

EMB currently has an ETF Daily News SMART Grade of A (Strong Buy), and is ranked #1 of 22 ETFs in the Emerging Markets Bonds ETFs category.


Rick Rieder, Managing Director, is BlackRock’s Chief Investment Officer of Global Fixed Income and is a regular contributor to The Blog.

Learn more about how consistent investment performance and low fees are critical to achieving your fixed income goals in today’s environment.

This article is brought to you courtesy of BlackRock.


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