‘The short end of the curve is very sexy today’: But where should ETF investors bet on bonds?

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The rise in bond yields keeps on resonating.

Investors now have an alternative to stocks, particularly with concerns over the Federal Reserve’s interest rate hikes potentially leading to a recession as soon as this year. That’s a theme that investors, including Fairlead Strategies founder Katie Stockton, addressed during a panel discussion on Feb. 7 at the Exchange conference at the Fontainebleau hotel in Miami Beach.

Stockton’s Fairlead Tactical Sector ETF
TACK,
-0.54%,
which relies on a technical model and factors such as price momentum to invest in a group of State Street’s SPDR ETFs, currently has the majority of its assets exposed to Treasurys. 

“It’s highly risk-off at this time,” Stockton said during an interview with MarketWatch on the sidelines of the event on Feb. 6. “In a perfect market,” the ETF would be invested across various sectors of the stock market, but energy
XLE,
-0.86%
is the sole sector left in the fund after the model kicked out utilities, she said.

Around 61% of the ETF’s assets were allocated to U.S. government debt, roughly split between short-term Treasurys
SPTS,
-0.07%
and long-term Treasurys
SPTL,
-0.82%
as of Feb. 8, according to the fund’s holdings data on its website. After fixed income, the ETF’s next biggest exposure was gold
GLD,
-0.79%
at around 22%, followed by energy at 12.5% and U.S. dollars at slightly more than 4%. 

The Fairlead Tactical Sector ETF, which aims for gains while limiting drawdowns, is up around 2% this year through Thursday, FactSet data show.

J.P. Morgan Asset Management’s chief global strategist David Kelly said Feb. 6 while on stage at the Exchange event that there’s a “one time only sale” in fixed income. Yields “all look good,” he said.

See: ‘Edge of a swamp’: JPMorgan strategist sees ‘one time only sale’ in fixed income as U.S. economy slows

Getting ‘paid to wait’

Michael Arone, chief investment strategist for SPDR ETFs at State Street Global Advisors, prefers short-term debt in the current environment. With the Fed signaling continued interest rate increases to bring down still high inflation in a slowing economy, caution is merited, Arone said in a Feb. 7 interview with MarketWatch, on the sidelines of the Exchange event. 

“We’re cautious” about taking on duration and credit risk, he said. Why take such risks when “I can get paid to wait” in the safety of short-duration, U.S. government debt, said Arone.

He pointed to attractive yields on Treasury bills with short durations of one to three months
BIL,
+0.03%
or three to 12 months, he said. The yield on one-month Treasury bills was trading around 4.6% on Thursday, while one-year Treasury bills were yielding around 4.9%, according to FactSet data. 

Bond yields and prices move in opposite directions. 

Fixed-income assets plunged in 2022 as the Fed aggressively raised rates to tame surging inflation. The pace of rate hikes has slowed as inflation has eased, but some investors worry that the central bank may keep interest rates elevated for a while before cutting them. 

See: Fed’s Waller says he’s prepared for ‘longer fight’ against inflation

Classic 60-40 portfolio

But after stocks and bonds slumped together last year, there’s “a good chance” that the asset classes go back to “negative correlations,” according to David Braun, a portfolio manager at PIMCO who shared the stage with Arone at the Exchange event to discuss the changing role of bonds in a Feb. 7 panel discussion. 

In an economic downturn, that means bonds may provide some cushion for investors – as well as income – in a classic portfolio consisting of 60% stocks and 40% bonds. Braun said on stage that he thinks it’s possible the Fed could cut rates later this year as a recession may be coming as inflation potentially continues to fall.

Read: U.S. Treasurys at ‘critical point’: Stocks, bonds correlation shifts as fixed-income market flashes recession warning

Arone said on stage that he doesn’t expect rate cuts this year, pointing to the strong U.S. labor market despite the Fed’s efforts to cool the economy. 

‘The problem with that’

While the bond market has been signaling recession fears, DoubleLine’s Jeffrey Sherman isn’t convinced the U.S. will see one this year. “The short end of the curve is very sexy today,” he said on stage during a panel on fixed-income perspectives at the Exchange conference. “Cash is cool again.”

Still, Sherman, DoubleLine’s deputy chief investment officer, is not just betting on the short end of the bond market’s yield curve. “The problem with that is that it doesn’t win if bad things happen,” he said.

Sherman told MarketWatch in an interview on the sidelines of the event that longer-term Treasurys can help balance a portfolio as their prices would typically rise as investors piled into them on recession fears. As for credit risk, Sherman said he sees opportunities in seeking yield in areas such as collateralized loan obligations, particularly the safest slice of CLOs. 

Passive vs. active?

After an “extremely rough” ride in the fixed-income market last year, there’s now “tremendous opportunity” for bond investors, said Steve Laipply, U.S. head of fixed income ETFs at BlackRock, while sharing his views on stage next to Sherman at the Exchange event.

Read: Where BlackRock sees ‘tremendous’ market opportunities for ETF investors in 2023 after damage to stocks, bonds

Also see: ‘Please have some fixed income’: Why ETF investors poured capital into bonds, international stocks in January

Laipply described the debate around active versus passive investing as an “old framing,” saying both strategies may be used in a portfolio. In an interview with MarketWatch after the panel, Laipply explained that in the traditional 60-40 portfolio, the 40% allocation to bonds could include a core holding of passive ETFs as well some actively managed funds that provide exposure to different areas of the fixed-income market.

In January, BlackRock launched the BlackRock AAA CLO ETF
CLOA,
+0.02%,
an actively managed fund that provides exposure to collateralized loan obligations, or CLOs, with AAA ratings. CLOs buy leveraged loans, a form of risky corporate debt.

Meanwhile, Janus Henderson’s AAA CLO ETF
JAAA,
+0.04%,
which launched in 2020, had a total return last year of 0.5%, according to FactSet data. The fund, which invests in high-quality CLOs, is up 1.6% so far this year on a total return basis through Wednesday.

As usual, here’s your look at the top- and bottom-performing ETFs over the past week through Wednesday, according to FactSet data.

The good…

…and the bad

New ETFs

• Calamos Investments announced Feb. 6 that it listed the Calamos Antetokounmpo Global Sustainable Equities ETF
  SROI,
  -0.25%,
  a fund that invests in “high quality and growth-oriented ESG-principled companies.” The ETF was launched in partnership with professional athlete Giannis Antetokounmpo, who plays for the National Basketball Association’s Milwaukee Bucks.

• Subversive Capital Advisor said Feb. 7 that it launched the Unusual Whales Subversive Democratic Trading ETF
  NANC,
  -0.96%
  and Unusual Whales Subversive Republican Trading ETF
  KRUZ,
  -0.64%.
  “Subversive does not express a view on the NANC and KRUZ underlying equities, rather, we buy or sell securities based on Unusual Whales’ reporting of what members of Congress disclose they hold,” said Christian Cooper, the ETF’s portfolio manager, in the announcement.

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