When bond yields rise and the fixed income market becomes more volatile, active management can be key, says senior portfolio manager Andrew Kronschnabel.
The rise in yields has been driven by the Federal Reserve, Kronschnabel said during a late-October interview.
The Fed has raised interest rates three times this year in response to strong economic data. Kronschnabel is expecting another interest rate hike in December and, as a result, more volatility. For 2019, the Fed forecasts three more hikes.
“A lot of the recent volatility in the fixed income market is reaction to the removal of extreme accommodation that’s been present for the past decade,” said Kronschnabel, who works at Logan Circle Partners, a MetLife affiliate in Philadelphia. “That’s both in the form of Federal Reserve and foreign central bank balance sheet size, and [the] Federal Reserve increasing interest rates.”
At the beginning of October, the U.S. 10-year Treasury yield rose above 3.2%, its highest level since 2011. This has weighed on bond prices, which move in the opposite direction as yields. Yields spiked above 3.2% again in early November.
Active management of bond portfolios involves making decisions about which issuers are likely to outperform in volatile times, he said.
“We have a lot of levers we can pull to respond to volatility in the fixed income market,” said Kronschnabel, who co-manages the Renaissance U.S. Dollar Corporate Bond Fund. That portfolio includes a mix of U.S. investment-grade corporates and high-yield U.S. corporate bonds, alongside U.S. bank loans.
“As volatility increases we can dynamically change the mix of those assets in the portfolio to react to that volatility,” he said. As of late October, he’d reduced his exposure to U.S. high-yield bonds and invested more in U.S. bank loans. The latter have “much less duration sensitivity, or much less interest rate sensitivity, as interest rates continue to rise through the end of the year and 2019,” he said.
Another option is to “take risk out of the portfolio altogether and invest in U.S. Treasurys,” he said. Kronschnabel recently took this approach and had 5% of the portfolio allocation to Treasurys at the time of the interview.
“We really think of that as dry powder that we have to allocate in the market in times of volatility,” he said.
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