BOND - BOND: Not A Bad Choice For Bond Investors

2023-09-18 06:59:37 ET

Summary

• PIMCO Active Bond ETF invests in a mix of government, mortgage, and corporate bonds, making it a good addition to a stock and bond portfolio.
• It's generally less volatile than long-term bonds and bond funds because most of its bonds mature in 5-10 years.
• The fund has a distribution yield of roughly 5% and allocates 60% of its assets to mortgage-backed securities, but without leveraging, making it less risky than mREITs.
• Hard to tell what the Fed will do in the future but rates are most likely closer to the top of their range than the bottom right now.

PIMCO Active Bond Exchange-Traded Fund ETF ( BOND ) invests into a large number of bonds that include a mix of government bonds, Federally backed mortgage bonds and corporate bonds and includes some foreign exposure. This fund could be a good addition to bond portion of your portfolio if your portfolio consists of a mix between stocks and bonds.

The fund holds more than a thousand bonds but top 10 holdings account for more than 35% of its total weight so this fund is rather top-heavy. The fund's top holdings are mostly either government treasury bonds or mortgage bonds backed by the government including yields ranging from 3% to 5.5%.

The fund currently has a distribution yield of roughly 5% which is in line with short-term treasuries. The fund is actively managed so its holdings could change from day to day but it typically invests 60% of its assets into Securitized bonds (basically mortgage backed assets), 15% into US government treasuries and another 20% into a mix of investment grade bonds. People who follow me and read my articles might be alarmed that 60% of the fund's assets are allocated to mortgage backed assets because I am usually not a big fan of mREITs that invest into these types of assets including government (or agency) backed mortgages. As a matter of fact I am not against investing into mortgage assets per se but I am against leveraging on them like a lot of mREITs do. This fund doesn't use leverage on mortgage backed securities so it doesn't contain nearly as much risks as mREITs even though it's not entirely risk-free as no investment ever is no matter what people might want to tell you.

About two-thirds of the assets being held by the fund have a maturity schedule of 5 to 10 years with average effective maturity being 9.72 years. I would call this medium-termed since anything below 3 years is considered short-term and anything above 10 years is considered long-term. These days due to the tightness of the yield curve, there is very little difference in buying bonds that are 6 months out, 12 months out, 3 years out or 5 years out. When things are "normal" bond yields tend to rise as maturities get longer but this is not the case right now with inverted yield curve where short term bonds yield 5.5% and long term bonds only yield about 4%. If the yield doesn't change much from different maturity yields, what should investors do? If they want to remain excessively risk aversive they would be buying short-term bonds since they would get paid the same for less risk. If they are in this for the long term, they would want to buy bonds with 5-10 year range so that they can lock these higher rates. After all, if you keep buying and rolling short term bonds, you will lose your high yield once bond yields drop but if you bought a medium term bond, your yield will remain high for the remainder of that yield's term.

Last year the Fed was in a hurry to hike rates in order to tackle the inflation as CPI rose to highest levels in 40 years. The pace of rate hikes we saw last year was one of the fastest in history as Fed hiked its funds rate from virtually 0% to 5.5%. As inflation rates dropped from 9.5% to 3.5% along with a slowdown in the economy, there are expectations that we will see a pause in rate hikes if not a rate cut in the coming months. Meanwhile, the rate of drop in CPI has stalled in recent years which also makes it less likely that the Fed will loosen its money policy anytime soon. Still, we are likely to be closer to the top than bottom as much as rates go. The Fed could hike rates once or twice more but I don't see rates climbing much above 6% when CPI is down to 3% levels even if it stalls there for a while. I can totally see the Fed not cutting rates for at least another year in the absence of a recession though. This means short and medium bonds will continue yielding about 5% which makes BOND a decent place to park money.

One thing that seems to leave everyone puzzled is lack of a rise in unemployment. Even the Fed's chairman Jerome Powell voiced his surprised several times that the unemployment rate is staying stubbornly low and labor market is stubbornly strong. I can't help but wonder if this is partially caused or at least helped by the rise in the gig-economy. Until not long ago if someone got laid off from work or lost their job, they had no choice but to spend months looking for a new job while drawing unemployment checks. Now people simply pick up a gig job like delivering things for Uber Eats ( UBER ) or Amazon ( AMZN ) which might not pay a lot but at least it keeps people employed. This could be contributing to the stubbornly low unemployment rates we are seeing in the economy and I am surprised that no one has mentioned this before including any of the Fed officers who constantly talk about surprising strength of the labor market.

This fund's share price is down about 20% from its recent highs but this should come as no surprise since bonds prices are down across the board. When rates go up, bond prices drop in proportion and vice-versa. This means that when bond yields return to "normal" levels, we might see a modest increase in share price of this fund. Typically short-term bonds are less affected by fluctuations in yields as compared to long-term bonds because they are close to maturity and investors are less worried about yield fluctuations since they will get their full money back soon anyways. Long-term bond prices fluctuate way more including government treasuries.

Last year many bond investors got caught off guard because they didn't expect bond prices to drop so much. Typically when stocks are in a bear market, bonds are seen as safe haven and people buy bonds. This time we had a bear market in both stocks and bonds at the same time which is rare. As a matter of fact, the bear market in bonds was even more brutal than what we saw in stocks and it is probably still not fully finished even though the bear market in stocks seems to be already behind us. At the end of the day, bonds didn't end up being a safe haven during last year's market carnage which left a sour taste in many bond investors' mouths. Then again this might be the best time to buy bonds for long term investors because yields are high and there is room for price appreciation. Besides, they say that the best time to buy any asset class is when it is in a bear market and there is "blood in the streets" as many investing gurus including Mr. Buffett say.

Don't expect bonds to beat stocks in performance though. In the long run, stocks still win by a large margin. While stocks represent growth, bonds mostly represent safety and diversification (but not always as we found out last year). In the long run stocks are where you most likely want to be but bonds have their uses too.

Bonds are also a good place to "park" your cash while trying to decide where to eventually invest it. Many people seem to think that the best days of stocks are behind us and we are overdue for a correction since stock prices are at historically high values. If you are one of those investors and waiting for the market to correct to more reasonable values, this fund is a good place to park your money and get paid while waiting for that correction to occur (which may or may not happen).

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