Active versus Passive Fixed Income Investing

Published by

Sep 13, 2019

Active vs. Passive Investing

An Enhanced Approach to Fixed Income Investing That Actually Works

 An Enhanced approach according to Whitetip capital

Beginning back in 1983 stocks have yielded an annualized return of approximately 10.9% (Display 1). Corporate High-yields have nearly equaled that performance, with a 9.5% return over a period spanning two full market cycles as well as countless rallies and sell-offs. The two asset classes can’t be compared over a longer time frame because earlier high-yield index returns don’t exist. But the 10.9% annualized return for stocks is roughly on par with performance dating back to 1927, so these performance patterns appear to be fairly consistent over time.

High yield bonds have outperformed other fixed-income classes

According to Bank of America Merrill Lynch, high yield bonds represented by the BofA Merrill Lynch US Cash Pay High Yield Index outperformed investment-grade bonds represented by the BofA Merrill Lynch US Corporate Index by 1.4% between January 1993 and September 2016. The BofA Merrill Lynch US Cash Pay High Yield Index provided an average annual return of 8.2%, compared with 6.7% for the BofA Merrill Lynch US Corporate Index.

Treasuries and High-Yield Corporate Bonds

The most basic strategy in fixed income is between Treasury bonds and high-yield corporate bonds. The Tactical strategy allocates between the two asset classes.

In difficult market environments, Treasury bonds rise in value as a flight-to-quality instrument while risky assets sell-off as credit spreads widen. In improving economic environments as we have seen in 2013, speculative-grade credit spreads improve while Treasury bonds often weaken due to the expectation of rising inflation that lowers real returns.

Another way to demonstrate the consistency of the enhanced strategy is to examine annual total returns, as indicated in the table. A simple momentum strategy only produced one negative total return in the past thirty years, and that was during the great interest rate selloff of 1994, the only year that both Treasuries and high yield bonds both produced negative total returns. Rotating between high yield bonds and Treasuries has produced long-run alpha

 
  

 

 

 

 

 

 

The long-run alpha demonstrated in the table and chart above was achieved by the process of owning either the Barclays Treasury Index (replicated through GOVT) or the Barclays U.S. Corporate High Yield Index (approximated through JNK) utilizing a simple tactical approach. The chart below demonstrates when the system is invested and when the system is defensive.

 

This is a time tested, proven systematic approach using a proprietary, computer-driven, quant style strategy, with multiple factors to identify market entry and exit points within the fixed income sector.

Why it actually works: High Yields vs. Treasuries

The important thing to remember is that not all bonds behave the same. High Yields versus Treasuries historically have been (as seen below) in many market environments on opposite ends of the spectrum to one another. High Yields move slower with the equity markets and with less volatility.  We utilize this asset class for our “risk-on” trade. Treasuries usually are implemented as a safe haven or a “risk-off” trade until markets land on a more stable footing. When neither asset classes fit our technical parameters, we allocate to cash and money markets until we see a more suitable time to reposition portfolios.


Articles authored by Martin Signer

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