Duration Risk is a Key Concern of Bond Investors as Credit and Spread Levels Have Some Fundamental Support, Says Market Vectors' Fran Rodilosso
NEW YORK--(BUSINESS WIRE)-- Duration* risk remains a key concern of fixed income investors, who continue to keep a keen eye on the Federal Open Markets Committee (FOMC), the impact of quantitative easing (QE), and the formation of an exit plan, says Fran Rodilosso, Fixed Income Portfolio Manager at Market Vectors ETFs.
"Though well below historical averages, credit spreads could still be justified from a historical perspective by the underlying fundamentals, such as currently low default rates in the case of high-yield bonds," says Rodilosso. "The concern obviously is that when the Fed stops buying bonds, all fixed income markets will sell off, with the long end of the curves hardest hit. As a result, we continue to see substantial investor interest in low duration investment products that still carry some credit risk, and therefore offer higher yields."
Rodilosso cites leveraged loan and short maturity high-yield bond funds as examples of product categories that have been attracting substantial net inflows. Another approach that is seeing increased interest combines the income generating potential of high-yield bonds with a short Treasury bond strategy. "Though high-yield bonds have historically had a slightly negative correlation to Treasuries, there is a growing concern that, if and when Treasury yields rise significantly, the correlation will be quite high," according to Rodilosso. "Un-hedged exposure to high-yield bonds appears less attractive at such a low level of interest rates, in my opinion."
Rodilosso notes that a long high-yield bond, short Treasury bond strategy may provide a number of potential benefits to fixed income investors, including exposure to credit risk with less exposure to pure interest rate risk. Other potential benefits include a portfolio with positive carry (i.e., the difference between the yield on high-yield bonds and the cost to short U.S. Treasury notes), yet low interest rate duration. The high-yield bond component also offers current yield that is currently significantly higher than investment grade floating rate bonds, as demonstrated by yields** reported by Barclays High Yield Very Liquid and Barclays US Floating Rate Notes (<5 Y) indices, respectively. Additionally, the underlying high-yield bond components are generally more liquid than leveraged loans. "This approach is one way to address investor concerns about duration while continuing to generate income." However, Rodilosso does point out that this strategy is not without risk, particularly in risk-off environments when U.S. Treasuries rally and high-yield bonds decline.
One final point that Rodilosso raises is that positive carry can be accomplished in different ways: shorting physical Treasuries, an approach used by Market Vectors Treasury-Hedged High Yield Bond ETF (NYSE Arca: THHY), or shorting futures contracts on Treasuries. The net effects of these approaches are similar. In both cases, the expenses associated with obtaining such exposure are embedded in the total return of the short or future position. However, funds are required to disclose, as an expense, the interest expense associated with a short position whereas they are not required to disclose the same for a futures position. While this discrepancy does not have an impact on a fund's total return, it will result in a higher net expense ratio for a fund that shorts the physical Treasuries.
Mr. Rodilosso has 20 years of experience trading and managing risk in fixed income investment strategies, including 17 years covering emerging markets. Among the Market Vectors ETFs under his watch are Treasury-Hedged High Yield Bond ETF (NYSE Arca: THHY), Emerging Markets High Yield Bond ETF (NYSE Arca: HYEM), Fallen Angel High Yield Bond ETF (NYSE Arca: ANGL),International High Yield Bond ETF (NYSE Arca: IHY),Investment Grade Floating Rate ETF (NYSE Arca: FLTR), LatAm Aggregate Bond ETF (NYSE Arca: BONO), Emerging Markets Local Currency Bond ETF (NYSE Arca: EMLC) and Renminbi Bond ETF (NYSE Arca: CHLC). As of March 31, 2013, the total assets for these ETFs amounted to approximately $1.9 billion.
*Duration measures a bond's sensitivity to interest rate changes that reflects the change in a bond's price given a change in yield.
** Yield to Worst measures the lowest of either yield-to-maturity or yield-to-call date on every possible call date.
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About Market Vectors ETFs
Market Vectors exchange-traded products have been offered since 2006 and span many asset classes, including equities, fixed income (municipal and international bonds) and currency markets. The Market Vectors family totaled $26.1 billion in assets under management, making it the fifth largest ETP family in the U.S. and ninth largest worldwide as of March 31, 2013.
Market Vectors ETFs are sponsored by Van Eck Global. Founded in 1955, Van Eck Global was among the first U.S. money managers helping investors achieve greater diversification through global investing. Today, the firm continues this tradition by offering innovative, actively managed investment choices in hard assets, emerging markets, precious metals including gold, and other alternative asset classes. Van Eck Global has offices around the world and managed approximately $35 billion in investor assets as of March 31, 2013.
There are risks involved with investing in ETFs, including possible loss of money. Shares are not actively managed and are subject to risks similar to those of stocks, including those regarding short selling and margin maintenance requirements. Ordinary brokerage commissions apply. Debt securities carry interest rate and credit risk. Interest rate risk refers to the risk that bond prices generally fall as interest rates rise and vice versa. Credit risk is the risk of loss on an investment due to the deterioration of an issuer's financial health. The Funds' underlying securities may be subject to call risk, which may result in the Funds having to reinvest the proceeds at lower interest rates, resulting in a decline in the Funds' income.
The Funds may be subject to credit risk, interest rate risk and a greater risk of loss of income and principal than those holding higher rated securities. As the Funds may invest in securities denominated in foreign currencies and some of the income received by the Funds may be in foreign currency, changes in currency exchange rates may negatively impact the Funds' returns. Investments in emerging markets securities are subject to elevated risks which include, among others, expropriation, confiscatory taxation, issues with repatriation of investment income, limitations of foreign ownership, political instability, armed conflict and social instability. THHY is subject to risks associated with investing in high-yield securities; which include a greater risk of loss of income and principal than funds holding higher-rated securities, as well as concentration risk; credit risk; hedging risk; interest rate risk; and short sale risk. Investors should be willing to accept a high degree of volatility and the potential of significant loss. The Funds may loan their securities, which may subject them to additional credit and counterparty risk. For a more complete description of these and other risks, please refer to the Funds' prospectus and summary prospectus.
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The Barclays Capital High Yield Very Liquid Index includes publicly issued U.S. dollar denominated, non-investment grade, fixed-rate, taxable corporate bonds that have a remaining maturity of at least one year, regardless of optionality, are rated high-yield (Ba1/BB+/BB+ or below) using the middle rating of Moody's, S&P, and Fitch, respectively (before July 1, 2005, the lower of Moody's and S&P was used), and have $600 million or more of outstanding face value.
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