Investors are recognizing interest rates can’t stay as low as they have been forever and there is a realization the bull market that has been witnessed in fixed-income is going to end, says Matthew Tucker, Fixed Income Strategy Head at iShares Blackrock Inc.
What is interesting though is that every year, or rather every month, there is this same conversation about the Federal Reserve raising interest rates and tapering the quantitative easing program. However, iShares tends to see it in terms of fund flows and investor reaction. Since the 10-year yield crossed the 2 percent mark, renewed fear on rising interest rates seems to have been triggered. Under such circumstances, investors tend to shift funds into shorter duration and shorter maturity fixed income instruments, he observed.
Asked if the markets are currently witnessing such an adjustment, Matt answered in the affirmative. The first adjustment took place in February, followed by March and May, he added. However, investors need to realize that it is not the beginning of the end (of quantitative easing) and they still need to be mindful of the Fed and the latest jobs report. Until the Fed is able to achieve its goals in terms of reducing unemployment and inspiring growth, it is quite likely the economy will be in an environment where the central bank continues to provide accommodation through QE, he noted.
The month of May showed a lot of fund rotation in the fixed-income market. Investors moved money out of high-yield funds and into corporate bond funds. Asked to explain the latest rotation, Matt said investors are still looking for yields generally and money is still coming in into the fixed-income ETFs and fixed-income mutual funds.
But, because of the heightened (interest) rate risk, the incoming dollars are going into shorter duration funds and investors are moving out of longer duration and longer maturity funds. This is called the duration rotation where investors reduce their interest rate risk. The iShares QLTC has been the best performing fixed-income ETF in the market this year, returning little over three percent, and it really shows the investors’ preference for yield in this market.
Asked to comment on the current market, which seems to be totally driven by the Fed’s moves, Matt said investors need to ask themselves the role of fixed-income in their portfolio. If they look at fixed-income as a diversifier against other asset classes, they need to be patient.
Fixed-income won’t be the best-performer in every market conditions just like equities, but a smart well-balanced portfolio can help investors ride out these shocks. However, if investors want to get more tactical and tries to anticipate what’s happening, ETFs are a great tool for that since it allows you to position the portfolio and take advantage of the anticipated changes in rates and spreads, he concluded.
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