Volatility and rising rates in the U.S. are creating pockets of opportunity for fixed income investors. Yields on short and intermediate bonds are at their highest in over a decade and, given current durations, they provide investors a cushion to protect against rising rates.
Jim Dadura, CFA, Director of Fixed Income, and Mike Diehl, CFA, Senior Portfolio Manager, discuss the benefits of short-term bonds in today’s higher rate environment.
[Jim Dadura] Hello and welcome to the Segall Bryant & Hamill 2022 Investment Summit. My name is Jim Dadura. I’m the Director of Fixed Income. Today I’m going to be joined by Mike Diehl who is one of our Senior Portfolio Managers in Fixed Income and we’re going to talk about short-term investing. Hi Mike. This has been quite a year for Fixed Income. As of last night’s close, the broad investment market, bond market, was down over 12%. How has the short-term maturity investment market performed?
[Mike Diehl] Hi, Jim. Happy to be here. The short-term market, it’s done significantly better than the long-term, so that’s the good news. The bad news is it’s still down 4% as of last night, but there are some positives that’s come out of this negative performance. We now have significantly higher yields in short-maturity securities, and I think people forget how low yields were, but in 2021 you had a 2-year Treasury that yielded 20 basis points. Your 3-year Treasury yielded 30 basis points. Now, those are well above 4%. They’re down a little bit, but they had peaked at 4.70%. So, performance has been bad, better than broader, longer duration benchmarks, but these yields have created some opportunities for investors going forward.
[Dadura] Well, Mike, the Federal Reserve (Fed) has been raising interest rates and is expected to continue to raise interest rates in the next few meetings. Does this present any risk to short-maturity investments?
[Diehl] That’s a great question, Jim. It does potentially cause some near-term risk. If the Fed is supposed to increase rates more aggressively, more than is expected in the marketplace, you could see a significant move higher in rates. That being said, there’s a lot of cushion in the short-duration market right now, given that yield move we talked about earlier. So right now, short-duration securities, in this case we define them as 0-3 year securities. On the chart, it’s the benchmark we use the Bloomberg U.S. Government/Credit 1-3 Year Index. This chart shows the yield and the duration for this index going back over 10 years. And what you can see on the chart is yield duration is basically the same. It’s a static benchmark, 1-3 years so the duration is the same. What has changed are yields. They’re significantly higher. As you see in 2020, I talked about yields were super low, we’re talking 20, 30 basis points. You have a duration of 1.9. Investors didn’t have any cushion to deal with the increase in interest rates, and we’ve seen that with this benchmark being down 4% for the year. Conversely, now you have the yields in this benchmark that are significantly higher, close to 4.50%. The duration is the same, 1.9. So, if we get another increase in interest rates, like you talked about earlier, the Fed continues to raise rates, investors have a significant amount of cushion in that the income this portfolio is generating easily offsets any potential negative returns due to increasing interest rates.
[Dadura] Thanks. My short-term investments do appear to be much more attractive than they were last year. Are there any investments you prefer in the short maturities over others?
[Diehl] Another good question, Jim. Yeah, I think short duration has been a focus for a lot of our clients and numerous investors, and we’ve seen a lot of money come into short-duration securities. Right now, I prefer high quality securities — high quality corporate securities or U.S. Treasuries — and there’s a few reasons for that. One, just given this insatiable demand we’ve seen for short-duration securities, there’s not a lot of yield pickup investors are getting going down the credit quality spectrum, so you’re not getting significantly more yield by investing in lower quality corporate securities. Conversely, that’s why we tend to focus on higher quality securities, and even Treasuries, just because investors aren’t, in our opinion, getting paid to take the extra credit risk in short-duration maturities. Secondly, high quality protects investors in times of economic stress or even a recession. You talked about the Fed continuing to raise interest rates. There is a possibility they have to raise interest rates enough that there is an economic downturn or even a recession. When these events happen, we’ve seen it in the Great Financial Crisis, we’ve seen it in March of 2020, a lot of investors rely on their short-duration investments to fund their liquidity needs, and conversely, you can see a mass exodus of some of these large mutual funds in the short-duration space, and that can spread across all short-duration maturities. By focusing on high quality corporate securities or Treasuries, we can immunize some of this risk and use it to our advantage in that if the market reacts in times of stress we find this is a great opportunity to add very high quality credits for our clients while maintaining that high liquidity needs if anything should come up.
[Dadura] Well, thank you, Mike, for your insights. Thank you all for joining us. If you’d like any additional information on our short maturity strategies, please contact your Segall Bryant and Hamill sales representative. Thank you.
The opinions expressed in this video are solely the opinions of Segall Bryant & Hamill or an unaffiliated third party. You should not treat any opinion in this video as specific inducement to make a particular investment or follow a particular strategy, but only as an expression of opinions. The opinions expressed in this video are based upon information considered reliable, but completeness or accuracy is not warranted, and it should not be relied upon as such. Market conditions are subject to change at any time, and no forecast can be guaranteed. Any and all information perceived from this video does not constitute financial, legal, tax, or other professional advice and is not intended as a substitute for consultation with a qualified professional. The opinions and statements are subject to change without notice and Segall Bryant & Hamill is not obligated to update or correct any information in this video. For illustrative purposes only.
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