Why It s Not Your Grandma s Bond Market Anymore

Transcription

1 Why It s Not Your Grandma s Bond Anymore Commentary November 2017 TODAY S BOND MARKET LOOKS QUITE DIFFERENT FROM A GENERATION AGO. Sources of return have evolved and certain strategies that used to work are less effective. We believe three fundamental changes a broadening investment universe, the changing nature of fixed income benchmarks and low interest rates mean investors should rely on a flexible, actively managed approach that is nimble enough to exploit market opportunities as they develop. Change One: Investment Opportunities Have Expanded As global capital markets have evolved, so have investment opportunities in fixed income. The bond market now includes high yield debt, non-government-issued securitized debt and preferred securities, investments that were not as broadly available 30 years ago. In addition, Exhibit 1 shows a large and growing share of the world s fixed income market now exists outside the United States. Exhibit 1: A Growing Share of the World s Fixed Income Is Outside the Tim Palmer Portfolio Manager Nuveen Asset Management, LLC Non 43% 57% 39% 61% $60.0 Trillion 2006 $91.4 Trillion 2016 Source: Bank of International Settlement Quarterly Review, September Data as of 12/31/06 and 12/31/16. Composition of the global bond market by market capitalization. Note: 2016 data removes the effect of the 10. appreciation of the dollar from June 2006 to June As the global market has expanded, its composition has changed from predominantly government-issued securities in hard currencies to a broad range of different sectors and local currency issues. Today s fixed income market varies by country, sector, currency and quality, creating a broader array of investment opportunities, as shown in Exhibit 2. Paul Blomgren Client Portfolio Manager Nuveen Asset Management, LLC NOT FDIC INSURED NO BANK GUARANTEE MAY LOSE VALUE

2 Exhibit 2: The Universe Has Become More Varied Bloomberg Barclays Global Aggregate Bond Index By Sector National Gov t 54% Gov t-related 1 Corporate 19% Passthrough 11% Securitized 4% By Region 39% Europe 3 Asia & Pacific Rim 20% Other 9% By Currency Dollar 4 European Euro 2 Japanese Yen 16% Other 14% By Quality AAA 39% AA 16% A 27% BBB 17% Source: Bloomberg L.P. Data as of 9/30/17. Change Two: Benchmarks Have Not Kept Pace with This Expansion The composition of the global fixed income market has changed, but the main benchmark for bonds has not. The Bloomberg Barclays Aggregate Bond Index reflects little of the diversity available to fixed income investors today. As shown in Exhibit 3, it consists primarily of traditional fixed income investments, such as Treasury and agency debt, investment grade corporate bonds and mortgage-backed securities. All securities are denominated in dollars, and it contains no below investment grade issues. However, Exhibit 4 shows that many of the highest returning sectors of the fixed income marketplace exist outside this traditional benchmark. While these sectors do present additional risks and volatility potential, careful credit research and active management can help reduce these factors. Exhibit 3: Aggregate Bond Index Consists of Traditional Investments Exhibit 4: Non-Index Fixed Income Sectors Have Offered Higher Returns Treasuries Government- Related Investment Grade Corporate Bonds Asset- Commercial Total Return (in %) 5-Year Treasuries 10-Year Agencies Investment Grade Mortgage Asset Commerical Preferred Mortgage- Not in Index 7.9 High Yield Bond Dollar Local Currency Source: Bloomberg L.P. Data as of 9/30/17. Based on the Bloomberg Barclays Aggregate Bond Index. Source: Morningstar Direct, 9/30/17. Past performance is no guarantee of future results. Representative Indexes: Treasuries: Bloomberg Barclays Treasury Index; Agencies: Bloomberg Barclays Agency Index; Investment Grade : Bloomberg Barclays Corporate Investment Grade Index; MBS: by Bloomberg Barclays Mortgage- (MBS) Index; ABS: by Bloomberg Barclays ABS Index; CMBS: by Bloomberg Barclays CMBS Index; Preferred : BofA Merrill Lynch Preferred Stock Fixed Rate Index; High Yield: Bloomberg Barclays Corporate High Yield Issuer Capped Index; Dollar s: Bloomberg Barclays USD Aggregate Index; Local Currency s: JPMorgan Government Bond Index s Local Index. Indices are unmanaged and unavailable for direct investment. 2

3 Index Dominated by Lower Yielding, Interest Rate Sensitive Bonds At the same time, Exhibit 5 shows that the composition of the Bloomberg Barclays Aggregate Bond Index remains dominated by government and government-related mortgage securities that offer relatively low yields. A portfolio that mirrors the benchmark will contain predominately lower yielding, government-related bonds. These bonds are exposed to a set of highly correlated risks and are also more sensitive to rising rates. Exhibit 5: Today s Aggregate Index Is Dominated by Government Risk 100% 80% 60% Treasury Agency Agency MBS 37% 28% Growing Treasury weight concentrates exposure to interest rate risk as well as the risk of potential missteps in monetary and fiscal policy. 40% 20% 0% CMBS/ABS Investment Grade Credit % 2017 Agency mortgage-backed securities have become increasingly tied to Treasuries as the Federal Reserve has been the dominant buyer of both asset classes. Source: Bloomberg L.P. Data as of 9/30/17. Based on the Bloomberg Barclays Aggregate Bond Index. To build a diversified fixed income portfolio that best balances yield and interest rate sensitivity, an investor will likely have to move beyond the limited traditional market segments, as shown in Exhibit 6. Exhibit 6: Non-Treasury Sectors Offer More Yield Potential with Less Rate Sensitivity Yield Correlation to 10-Year Treasury Return Not in Index % % 2.7% % Treasuries Commercial Investment Grade Preferred High Yield Source: Bloomberg L.P.; BofA Merrill Lynch; Morningstar Direct. Yields as of 9/30/17. Correlation to 10-Year Treasury Returns from 10/1/06-9/30/17. Past performance is no guarantee of future results. Representative Indexes: 10-Year Treasury: Bloomberg Barclays Treasury Bellwether 10-Year Index; Treasury: Bloomberg Barclays Treasury Index; MBS: Bloomberg Barclays (MBS) Index; CMBS: Bloomberg Barclays CMBS Index; Investment Grade : Bloomberg Barclays Corporate Investment Grade Index; Preferred : 6 BofA Merrill Lynch Preferred Stock Fixed Rate Index/3 Bloomberg Barclays USD Capital Index; High Yield: Bloomberg Barclays Corporate High Yield Issuer Capped Index; s: Bloomberg Barclays USD Aggregate Index. Indices are unmanaged and unavailable for direct investment. Correlation is a statistical measure of how two securities move in relation to each other. Change Three: Falling Rates Make It More Difficult to Find Yield For the past 30 years, interest rates have been steadily declining, as shown in Exhibit 7. In 1987, an investor could buy a 5-year Treasury bond yielding 8.40% with no apparent credit risk and very little interest rate risk. Now, a 5-year Treasury yields just 1.94%. To add more yield or return potential, an investor must assume credit risk or take on more interest rate risk. Therefore, to create a diversified portfolio with attractive yield and less interest rate sensitivity, today s investors must move beyond traditional market segments. 3

4 Exhibit 7: Treasuries Don t Yield What They Used To 30 years ago (12/31/87) 8.40% 8% 20 years ago (12/31/97) 10 years ago (12/31/07) Current (9/30/17) 8.86% 8.98% Yield 6% 4% 5.71% 3.44% 1.94% 5.74% % 2.33% % 0% 5-Year Treasury 10-Year Treasury Source: Bloomberg L.P. Past performance is no guarantee of future results. 30-Year Treasury What to Do? Stay Flexible and Broaden Your Investment Horizon With this extensive playing field and the current low rate environment, we believe a fixed income portfolio that includes non-index sectors has the potential to offer the best risk/return profile. At the same time, flexibility to manage the risks of these allocations is very important. Exhibit 8 illustrates the stark differences between a traditional benchmark-oriented approach and more diversified portfolios. Exhibit 8: Sample Fixed Income Portfolios Traditional Portfolio Portfolio 1 Portfolio 2 100% Aggregate Bond Index Preferred Dollar Denominated 20% High Yield Nondollar-Denominated Bonds Local Currency Denominated Risk/Return (Period Ending 9/30/17) 6% Portfolio 1 Portfolio 2 Yield=3.06% Yield=3.4 Traditional Portfolio Yield=2.5 4% Risk (10-Year Standard Deviation) Return (10-Year Total Return) Rising Rate Period Returns Increasing Fed Funds Rate: 6/1/04 6/30/06 Increasing Treasury Yields: 1/1/13 12/31/13 Traditional Portfolio Portfolio 1 Portfolio % 4.59% 5.63% % -0.53% Representative Indexes: Preferred : BofA Merrill Lynch Preferred Stock Fixed Rate Index; High Yield: Bloomberg Barclays High Yield Issuer Capped Index; Nondollar- Denominated Bonds: Bloomberg Barclays Global Aggregate Bond ex. USD Index; Dollar Denominated : Bloomberg Barclays USD Aggregate Index; Local Currency Denominated : JPMorgan Government Bond Index Global Index. Past performance is no guarantee of future results. Indices are unmanaged and unavailable for direct investment. 4

5 As the global fixed income markets have evolved, constructing efficient fixed income portfolios now requires investors to consider a broader array of investment options. An actively managed, broadly flexible and multisector approach can help investors create higher yield, with less exposure to rising rates. It s just not your grandma s bond market anymore. GLOSSARY Standard deviation is a measure of the variance of actual returns compared to average returns over a certain period. It is a common measure of volatility and risk. Hard Currency is a currency, usually from a G-10 country, that is widely accepted around the world as a form of payment for goods and services, such as the dollar, the European euro or the Japanese yen. The G-10 countries are France, Germany, Belgium, Italy, Japan, the Netherlands, Sweden, the United Kingdom, the United States and Canada, with Switzerland playing a minor role. Local Currency is a currency issued by smaller country or emerging market country that may not be broadly accepted in other countries, such as the Mexican peso, Indian rupee or South African rand. For more information, please consult with your financial advisor and visit nuveen.com. INDEX DEFINITIONS Bloomberg Barclays Asset Index is the corporate asset backed securities component of the Bloomberg Barclays Aggregate Index with maturities from one to three years. Bloomberg Barclays Commercial Mortgage Index measures the performance of the commercial mortgage-backed securities market. Bloomberg Barclays Agency Bond Index measures the performance of the agency sector of the government bond market and is composed of investment-grade native-currency Dollar-denominated debentures issued by government and government-related agencies, including the Federal National Mortgage Association ( Fannie-Mae ). Bloomberg Barclays Aggregate Index represents securities that are SEC-registered, taxable and dollar denominated. The index covers the investment grade fixed rate bond market, with index components for government and corporate securities, mortgage passthrough securities, and asset-backed securities. Bloomberg Barclays Global Aggregate Bond ex. Index provides a broad-based measure of the global investment-grade fixed income market outside of the United States. Bloomberg Barclays USD Aggregate Index includes USD-denominated debt from emerging markets around the world. Bloomberg Barclays USD Capital Index contains securities viewed as a hybrid fixed income securities that either receive regulatory capital treatment or a degree of equity credit from the rating agencies. This generally includes Tier 2/Lower Tier 2 bonds, perpetual step-up debt, step-up preferred securities, and term preferred securities. Bloomberg Barclays Corporate Investment Grade Index is a broad-based benchmark that measures the investment grade, fixed-rate, taxable corporate bond market. Bloomberg Barclays High Yield Issuer Capped Index is an unmanaged index that covers corporate, fixed-rate, non-investment grade debt with at least one year to maturity and at least $150 million in par outstanding. Index weights for each issuer are capped at. Bloomberg Barclays Bond Index is an unmanaged index that tracks total returns for external-currency-denominated debt instruments of the emerging markets. Bloomberg Barclays Mortgage Index covers agency mortgagebacked pass-through securities (both fixed-rate and hybrid ARM) issued by Ginnie Mae (GNMA), Fannie Mae (FNMA), and Freddie Mac (FHLMC). Bloomberg Barclays Treasury Index includes public obligations of the Treasury. Treasury bills are excluded by the maturity constraint but are part of a separate Short Treasury Index. In addition, certain special issues, such as state and local government series bonds (SLGs), as well as Treasury TIPS, are excluded. STRIPS are excluded from the index because their inclusion would result in double-counting. BofA Merrill Lynch Preferred Stock Fixed Rate Index is designed to replicate the total return of a diversified group of investment-grade preferred securities. JP Morgan Government Bond Index- s Index tracks debt of emerging market governments issued in local currency. This material is not intended to be a recommendation or investment advice, does not constitute a solicitation to buy or sell securities, and is not provided in a fiduciary capacity. The information provided does not take into account the specific objectives or circumstances of any particular investor, or suggest any specific course of action. Investment decisions should be made based on an investor s objectives and circumstances and in consultation with his or her advisors. RISKS AND OTHER IMPORTANT CONSIDERATIONS This analysis indicates past performance of market benchmarks over the time periods specified and in no way should be considered representative of the past performance of any actual investment product or predictive of future investment expectations and performance for these benchmarks or any actual investment products. Different benchmarks, methods and economic periods will produce different results. The results for individual portfolios may vary depending on market conditions and the composition of the portfolio. These index returns include reinvestment of income but do not reflect inflations, fees, taxes or transaction costs that would reduce performance in an actual account. All indices are unmanaged and unavailable for direct investment. The analysis contained herein is based on numerous assumptions. Different assumptions could result in materially different outcomes. This report is provided for informational and educational purposes only and contains no investment advice or recommendations to buy or sell any specific securities. The statements contained herein are based upon the opinions of Nuveen Asset Management, LLC and the data available at the time of publication. All opinions and views constitute our judgments as of the date of writing and are subject to change at any time without notice. Hypothetical examples are shown for illustrative and educational purposes only. Certain information was obtained from third party sources, which we believe is reliable, but not guaranteed for accuracy or completeness. The information provided does not take into account the specific objectives, financial situation, or particular needs of any specific person. All investments carry a certain degree of risk, including possible loss of principal, and there is no assurance that an investment will provide positive performance over any period of time. Investing involves risk; principal loss is possible. or fixed income securities are subject to market risk, credit risk, interest rate risk, call risk, derivatives risk, dollar roll transaction risk, and income risk. As interest rates rise, bond prices fall. Foreign investments involve additional risks, including currency fluctuation, political and economic instability, lack of liquidity, and differing legal and accounting standards. These risks are magnified in emerging markets. Asset-backed and mortgage-backed securities are subject to additional risks such as prepayment risk, liquidity risk, default risk and adverse economic developments. Non-investment-grade and unrated bonds with long maturities and durations carry heightened credit risk, liquidity risk, and potential for default. Nuveen Asset Management, LLC, a registered investment adviser, is an affiliate of Nuveen, LLC. GPE-GRBND-1117P INV-AN-11/18 Nuveen 333 West Wacker Drive Chicago, IL nuveen.com