In what was one of the worst years on record for the bond market and the worst for the Bloomberg US Aggregate Bond Index, advisors sourced some fixed income refuge for clients with ultra-short term bonds and the related funds.
While not perfect – no investment is – ultra-short term bonds were the ideal tonic in 2022 as the Federal Reserve boosted interest rates seven times. In other words, when interest rate risk is in the spotlight, reducing duration is paramount. Data confirm advisors’ embrace of ultra-short duration exchange traded funds in 2022.
“Amid the turmoil of 2022, many investors turned to ultra-short bond ETFs to de-risk portfolios,” according to State Street Global Advisors (SSGA). “The category amassed $57 billion in net inflows last year, eclipsing its 2018 calendar-year high of $49 billion. Yet broad investment-grade and high yield credit spreads currently below their 20-year averages suggest credit is still richly valued, despite falling 15.7% and 11.2% last year, respectively.”
Undoubtedly, there are expectations in place that Treasury yields will decline in 2023, but it’s also probable that the Fed raises rates a few times in the first half of the year. With that in mind, advisors may want to consider ultra-short term fixed income offerings again in 2023.
Rate Volatility Could Enhance Ultra-Short Term Appeal
While it’s likely the bond market will show improvement this year in terms of total returns, that doesn’t mean it’ll be bereft of volatility.
“Expect continued volatility in capital markets, spurred by a disconnect between investors and the Fed over the path of interest rates. Despite the Fed’s sustained hawkish rhetoric in the most recent meeting notes, Fed funds futures imply that rates could fall in the second half of the year,” adds SSGA.
On that note, advisors might want to consider deploying active management in the ultra-short term duration space. Broadly speaking, 2022 was another rough year for active managers, but that management still has applications in the bond market, particularly when it comes to guarding against interest rate risk.
“Short-term yields have risen much faster than long-term yields as rate hikes have not been felt equally across the maturity curve. As a result, the actively managed SPDR® SSGA Ultra Short Term Bond ETF (ULST) has become an increasingly attractive alternative to longer duration and higher credit risk bond exposures,” noted SSGA.
ULST has an option-adjusted duration of just 0.22 years, making its 30-day SEC yield of 4.53% downright exception. Plus, as the issuer notes, the fund is less volatile than 88% of competing strategies. Those are points for advisors to ponder.
How 2023 shakes out in the bond market remains to be seen, but when factoring in the possibility of both rate hikes early in the year and the potential for cuts later, active management and reducing duration could be assists for clients.
“ULST’s active approach has produced consistent results, both on a total return and risk-adjusted return basis. It ranks in or near the top quartile of its ETF and mutual fund peers over the trailing 1-, 3-, and 5-year periods, having outperformed its peer group median by 70 bps in 2022,” concludes SSGA. “The fund’s 0.84% return for 2022 ranked in the 23rd percentile for ultra-short investment-grade actively managed funds.”