2023-04-14 01:35:00 ET
Summary
- Shorter securities with appealing characteristics are available across fixed income markets.
- Recent market volatility aside, we believe central banks will have to maintain current policy for longer, with inflation likely not getting back to the 2% target before 2024.
- This means that yields across the short-dated fixed income complex are likely to remain compelling.
By Jason Pratt
Shorter securities with appealing characteristics are available across fixed income markets.
Recent market volatility aside, we believe central banks will have to maintain current policy for longer, with inflation likely not getting back to the 2% target before 2024.
This means that yields across the short-dated fixed income complex are likely to remain compelling. The fundamental backdrop and default environment also remain fairly benign, notwithstanding some idiosyncratic risk activity.
We think this opens the door to focus on extended short duration markets, including high yield and emerging markets debt (EMD), as well as investment grade credit.
Carry is a key component of available returns, fitting well with buy-and-maintain portfolios. That said, we believe some active management can enhance returns in a period where performance dispersion is more likely found at the issuer level.
Short-duration high yield is currently benefiting from the extension of the balance sheet runway, with issuers having termed out their debt on the back of COVID-19.
Today, issuers have more flexibility in managing their debt while facing a higher cost of capital. Broadly speaking, the quality of the high yield market is nearly as strong as it has ever been, which has been somewhat reflected in spread levels, although higher rates at the front end of the curve provide better compensation for the risk.
As measured by the ICE BofA 1-5 year U.S. Cash Pay High Yield Index, this market offers around 8.7% for 2-2.5 years of duration with the Federal Reserve closing in on the end of its rate hikes.
Short-duration EMD has historically been an oasis for yield and diversification, while posing limited interest rate risk. The sector is certainly sensitive to growth cycles and currency dynamics as it trades in hard-currency form.
Solvency capital requirement efficiency is compelling today with lower risks of default, given the investment-grade and the shorter-dated nature of the exposures.
With an investible universe of $1 trillion, the sector is well diversified with half the volatility of the broader EMD universe and compelling yields - typically targeting around 7.5% with duration of roughly two years.
Finally, short-duration investment grade credit similarly benefits from the shape of the U.S. yield curve and plays on the same themes as high yield in terms of balance sheet flexibility and cycle runway.
Yields in this segment are a bit lower, given the higher quality, at 5.% for roughly two years of duration on average within the ICE BofA 1-5 Year U.S. Corporate Index. These yield levels can help provide a foundation to underpin portfolios, which may help overcome lower existing book yields.
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Appealing Yields Point The Way To Short Duration