Introducing the WisdomTree Short Term Fixed Income Model
By Rick Harper, Kevin Flanagan and Scott Welch, CIMA
This article is for financial professionals who are considering offering model portfolios to their clients. If you are an individual investor interested in WisdomTree Model ETF Portfolios, please inquire with your financial professional. Not all finance professionals have access to these model portfolios.
Take a look at the following three graphics. The first shows the increasing duration of gross debt in the United States. Gross debt includes the debt of governments, households and non-financial corporations. As a reminder, duration is a measure of the sensitivity of bond prices to changes in interest rate, and it’s an inverse relationship: When rates go up, bond prices usually go down. The longer the term, the more sensitive bond prices are to changes in interest rates.
The second graph shows the evolution of interest rates over the last 12 months, especially the last three – a constant increase and which we believe will continue (with the 10-year cash flow perhaps reaching 1.75% to 2.00% by the end of the year).
For definitions of terms in the tables, please visit the glossary.
So higher rates and tight spreads. What is a poor bond investor supposed to do?
Introducing the WisdomTree Short Term Fixed Income Model
WisdomTree recently launched a short-term fixed income model, designed specifically to reduce interest rate risk without sacrificing too much in terms of performance, compared to the Bloomberg Barclays US Aggregate Bond Index. It can be used as a stand-alone bond model or as a complement to an existing bond allocation to reduce duration risk without disrupting existing allocations.
We’ve kept it simple and inexpensive: four tickers that provide diversification across all sectors while maintaining a low duration profile. While this is a straightforward construction, the four underlying funds incorporate some of our most sophisticated thinking to balance income opportunities and the risks they carry, fundamental filters within our investment strategies. cautious approach to improving the return built into our short-term core fund to our leverage. the in-depth expertise of Voya’s securitized debt team in finding opportunities in the securitized debt markets.
For the standardized and end-of-month performance of the funds mentioned above, click on here.
For a prospectus for the funds referenced above, click on here.
As of September 30, 2021, this model portfolio, using the weighted average return of the four underlying securities (since the model itself was launched a short time ago), showed a rolling 12-month return of 1.99% (with current yield – at worst 1.71%)1, while maintaining an average duration of 3.1 years.
In comparison, the Bloomberg Barclays US Aggregate Bond Index currently has an average duration of 6.71 years and offers a current yield of 1.56%. The rise in yield in the short duration model reflects that it takes more credit risk than the index.
Take a look at the following table. It shows the marginal increase in yield achieved as the duration increases. Historically, this relationship has been around 1: 1, or a 1% increase in yield for each additional year of life. This relationship is now at an all time low. Investors are simply not being rewarded at an appropriate level for taking additional interest rate risk, especially in an environment where we believe rates will continue to rise.
The compromise between duration and performance
With interest rates likely to rise and historically tight credit spreads, investors should not seek to take excessive interest rate risk in their fixed income allocations.
Our new short term fixed income model may be part of the solution. It can potentially help reduce interest rate risk (duration) while generating levels of return close to the index.
You can find out more about our Model adoption center. We hope you take a look.
1 âWorst returnâ is a measure of the lowest possible return achievable on a bond that fully meets its contractual obligations without default. It takes into account the bond provisions that allow the issuer to liquidate the debt before it matures (two examples are payability and the prepayment option on mortgages).
Initially published by WisdomTree on November 5, 2021.
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Significant risks associated with this article
There are risks associated with investing, including possible loss of capital. Fixed income investments are subject to interest rate risk; their value normally decreases as interest rates rise. Fixed income investments are also subject to credit risk, the risk that the issuer of a bond will not pay interest and principal on a timely basis, or that negative perceptions of the issuer’s ability to make money. such payments lower the price of this declining bond. Investing in mortgage and asset backed securities involves interest rate, credit, valuation, expansion and liquidity risks and the risk that payments on the underlying assets will be delayed, prepaid, subordinate or in default. High yield or âjunkâ bonds have lower credit ratings and carry greater risk to capital. Please read each Fund’s prospectus for specific details regarding the Fund’s risk profile.
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