By Kevin Flanagan, Head of Fixed Income Strategy, WisdomTree
“3 for 21” would not be an ideal stat in the sporting world. But for fixed income investors, we feel three will be an important number in 2021, as, in our opinion, it represents the number of key themes to focus on in the new year. Here’s a brief synopsis of these themes and how WisdomTree can help provide solutions for them in the fixed income universe.
1. Quality and Income
With interest rates at historical lows, investors will be tasked with looking for income without moving too far out in duration or, perhaps more importantly, sacrificing credit quality.
- The WisdomTree Yield Enhanced U.S. Aggregate Bond Fund (AGGY) offers investors just such a strategy. This fund re-weights the sectors of the Bloomberg Barclays U.S. Aggregate Bond Index (Agg) utilizing important guardrails to enhance yield while maintaining a familiar risk profile. This approach focuses on the investment-grade aspect while keeping away from high yield, emerging market debt and/or leverage, a desirable trait for core fixed income.
- The WisdomTree U.S. High Yield Corporate Bond Fund (WFHY) offers investors a quality screen while tilting for income. By focusing on only public issuers and their attendant balance sheets, we were able to identify “cash flow” as a vital attribute. We eliminate those issuers with negative cash flow, helping to address credit quality concerns and potentially mitigating default risk.
2. Reflation Trade
While we expect the Federal Reserve (Fed) to keep rates at or near zero, intermediate to longer-dated Treasury Yields could still grind higher, with the yield curve steepening due to unprecedented monetary and fiscal stimulus. Key factors such as pent-up demand and optimism surrounding the vaccine rollout could push inflation expectations and inflation headline readings higher in 2021.
- The WisdomTree Interest Rate Hedged High Yield Bond Fund (HYZD) offers investors a way to provide income while mitigating interest rate risk. This strategy utilizes our quality-screened high-yield approach while “zeroing” out duration. Thus, investors can address both income needs and rate concerns in just one Fund.
- The WisdomTree Floating Rate Treasury Fund (USFR) offers investors a rate-hedge strategy that focuses only on U.S. government securities and doesn’t include any credit issuers, unlike most, if not all, other existing floating rate options. This approach also offers an attractive alternative to inflation-protected securities without the longer duration they typically include.
3. Emerging Markets
With the global economic setting expected to improve after Q1 2021, accommodative central bank policies in both the developed and emerging market worlds and the potential for a softer U.S. dollar setting, we anticipate a favorable setting for local currency sovereign emerging market debt (EMD).
- The WisdomTree Emerging Markets Local Debt Fund (ELD) offers investors an approach to take advantage of the potential opportunities in the local currency EMD space while utilizing a process of continuous risk management. Key factors in the risk-monitoring process include growth/inflation indicators, debt service capability and short-term liquidity factors, enabling countries that exhibit fiscal/monetary discipline to receive an increase in their respective allocation.
On a final note: Happy Holidays!
Photo Credit: Justin Vidamo via Flickr Creative Commons
There are risks associated with investing, including possible loss of principal. High-yield or “junk” bonds have lower credit ratings and involve a greater risk to principal. Fixed income investments are subject to interest rate risk; their value will normally decline as interest rates rise. HYZD seeks to mitigate interest rate risk by taking short positions in U.S. Treasuries (or futures providing exposure to U.S. Treasuries), but there is no guarantee this will be achieved. Derivative investments can be volatile, and these investments may be less liquid than other securities, and more sensitive to the effects of varied economic conditions.
Fixed income investments are also subject to credit risk, the risk that the issuer of a bond will fail to pay interest and principal in a timely manner, or that negative perceptions of the issuer’s ability to make such payments will cause the price of that bond to decline. HYZD may engage in “short sale” transactions where losses may be exaggerated, potentially losing more money than the actual cost of the investment, and the third party to the short sale may fail to honor its contract terms, causing a loss to the Fund. While the Fund attempts to limit credit and counterparty exposure, the value of an investment in the Fund may change quickly and without warning in response to issuer or counterparty defaults and changes in the credit ratings of the Fund’s portfolio investments.
Securities with floating rates can be less sensitive to interest rate changes than securities with fixed interest rates, but may decline in value. The issuance of floating rate notes by the U.S. Treasury is new, and the amount of supply will be limited. The value of an investment in USFR may change quickly and without warning in response to issuer or counterparty defaults and changes in the credit ratings of the Fund’s portfolio investments.
While WFHY attempts to limit credit and counterparty exposure, the value of an investment in the Fund may change quickly and without warning in response to issuer or counterparty defaults and changes in the credit ratings of the Fund’s portfolio investments.
Foreign investing involves special risks, such as risk of loss from currency fluctuation or political or economic uncertainty. Investments in emerging, offshore or frontier markets are generally less liquid and less efficient than investments in developed markets and are subject to additional risks, such as risks of adverse governmental regulation and intervention or political developments. Investing in mortgage- and asset-backed securities involves interest rate, credit, valuation, extension and liquidity risks and the risk that payments on the underlying assets are delayed, prepaid, subordinated or defaulted on. Unlike typical exchange-traded funds, there is no index that ELD attempts to track or replicate. Thus, the ability of the Fund to achieve its objective will depend on the effectiveness of the portfolio manager. Due to the investment strategies of ELD, USFR, HYZD and AGGY, they may make higher capital gain distributions than other ETFs.