The past few months have been a chastening experience for anyone long Treasuries. The Bloomberg Barclays US Treasury Bond Long index has fallen an astonishing 8.1% from when yields started to rise in mid-December to February 22, 2018.
This is a much more significant event than the last time we saw a pronounced decline in bond values in the immediate aftermath of Donald Trump’s election victory, when Treasuries fell 4.1% in the fourth quarter of 2016.
What has been intriguing about this latest downturn, though, is just how localized the rising yields have been to the dollar debt market. Over the same period, sovereign debt in the rest of the developed world has actually risen by 3.6%. While economic activity is picking up the world over, inflation in Europe is not as prominent as it is in the US; the latest data point shows eurozone inflation at just over 1%.
But what of fixed income mutual funds? How have they fared during this latest sell-off? Rather than cycle out of debt markets altogether over the past few years, investors have ploughed into the more dynamic fixed income products found in Multi-Sector Income and, to a lesser extent, Flexible Income. This move has been rewarded with strong returns, as most investors have been able to take advantage of the rallies in the high yield and corporate credit markets.
However, in this latest downturn they have not been able to immunize their portfolios against the rattled fixed income market, with Multi Sector Income funds falling by an average of 0.63% and Flexible Income down 0.62%. Of course, this is unlikely to cause investors much concern, and these numbers compare relatively favorably with the Barclays US Aggregate Bond index’s 2.44% decline.
The fund of the moment, Pimco Income, lagged the peer group slightly, falling 0.82% in the recent turmoil. This is hardly a disaster, but negative returns for this fund are now such a rarity that it is certainly noteworthy.
It will be interesting to see when managers in these two categories choose to start bulking up on Treasuries, which have been shunned rather aggressively in recent years. Many managers expect this volatility to create more opportunities, and we may have passed the tipping point.
So what became of Liquid Alternative Bond Strategy funds? After all, this is what these hedge fund-lite products were built for, weathering the storm by aggressively employing derivatives. That said, they have rarely had an opportunity to test their mettle.
The good news is that they have passed the test, with the average fund rising by 0.45% during the volatility. While this is impressive when pitted against traditional domestic fixed income products, these funds are much more inclined to spread their exposure globally. Investors would actually have been better off in the International Income category, which rose by 1.5% over the same period.
I’m still a huge proponent of this new breed of fixed income funds. If you must invest in fixed income in the current climate, the low correlations and volatility on offer make them an attractive choice. However, for them to really show their stripes, you would need a global systemic correction within the fixed income market. While that hasn’t arrived just yet, these funds have once again proved to be a useful diversifier for yield-hungry investors.