Posts Tagged ‘Bond Fund’

Inside the Mind of Jeffrey Gundlach

Wednesday, April 24th, 2013

Guest Contribution by Eddy Elfenbein, Crossing Wall Street

Gundlach

Jeffrey Gundlach is a prophet, a mathematician, an art aficionado and occasional dabbler in painting, a former drummer in a failed rock band, a sometime student of philosophy, a reciter of poetry, a blowhard, a consumer of sports automobiles and crossword puzzles, and an egotist of striking dimensions.

He’s also a man with a genuinely original mind, as well as the manager of one of top-performing bond funds on the market. His firm, DoubleLine Capital LP, is the fastest-growing mutual fund startup in history. Its DoubleLine Total Return Bond Fund has yielded an annual average of 11.50% since its inception and amassed some $50 billion in assets. (For comparison, bond king Bill Gross’s $290-billion Pimco Total Return Fund netted an average of 6.96% for the same period.) Gundlach is also a man who inspires fierce loyalty in his subalterns. When he was fired from Trust Company of the West, his old employer, in December of 2009 and went off to start his own firm, 45 of his 65 team members quit their very comfortable jobs to step out into the great unknown with him.

He is, in short, an individual, in the honorific sense of the word. If his pronouncements are frequently over the top, his uncanny penetration makes him hard to write off. Blowhards are quickly forgiven if they have the chops to back up their swag.

His beginnings are ordinary enough. A Buffalo childhood in a modest, middle-class home (father an industrial chemist, mother a housewife); near-perfect SATs, back when that was a real accomplishment; four years at Dartmouth on a scholarship; summa cum laude in philosophy and mathematics. All par for the course among America’s best and brightest. After that, Gundlach enrolled in a Ph.D. program in theoretical mathematics at Yale, seemingly for lack of anything better to do.

In an alternate universe, he would have gone on to a respectable professorial career, and his weekend gigs with his new-wave band would have made him the cool prof in the eyes of his students. But there were problems. First, there was his thesis. When he told his dissertation adviser that he wanted to prove that infinity didn’t exist, he was told that his topic was outside the “mainstream interests” of Yale’s mathematics faculty. Second, his expansive side was getting restless. Yale and the academic game were too confining. So he dropped out and moved to California, where he gigged with a couple more bands and slowly went broke.

Suddenly, he decided he wanted to be rich. It was the 80s, and in the 80s if you wanted to be rich, you were an investment banker. So he called up Trust Company of the West, offered them his services as a mathematician, landed an interview, and started his first real job. He would stay at that job a quarter of a century, becoming manager of a $500-million fund at age 28 and pulling down a million dollars a year by age 30. When the financial crisis hit in 2007, his TCW Total Return fund still averaged an amazing 9.1% annually for the next three years. His team was by now managing almost all of TCW’s assets. Gundlach had made himself into that rarest of creatures in American business: someone who is irreplaceable.

Except that TCW didn’t understand that. In December of 2009, in what seems an act of incomprehensible self-sabotage, they fired him, charging he was conspiring to pilfer the company’s staff, steal its databases and client lists, and start his own firm. The charges were unjust, thus impelling Gundlach to…raid the company’s staff, reconstruct its client lists, and start his own firm. TCW filed suit; Gundlach filed a countersuit—and won, collecting $67 million in unpaid wages for himself and his associates. Meanwhile, he and they were frenetically scrambling to scrape together capital for their new mutual funds. Even with the litigation cloud hanging over them, they still succeeded in aggregating $7 billion inside their first year, largely on the strength of Gundlach’s reputation for delivering results.

How those results are obtained principally involves mortgage-backed securities, of both the guaranteed and the non-guaranteed variety. The former are insured by the government corporations Fannie Mae and Freddie Mac and yield lower returns, making them more popular when the market is bearish, while the latter are issued directly by banks and other financial institutions and thus carry more risk, causing them to yield higher returns when the market is in its bull phase. Thus far, Gundlach’s distinctive blend of the two in his bond portfolio has continuously trumped other players in the game.

But Gundlach isn’t given to boosterish optimism. Lately his thinking has taken a prophetic turn, and a gloomy one at that. He’s always been one to look at the big picture—he’s one of the analysts who correctly predicted the subprime-mortgage debacle—and in the next few years he foresees several national economies entering what he calls “Phase Three,” which entails defaulting on their national debts and receiving further government stimulus-spending as triage. This, he says, will cause inflation to spike, but also create unprecedented opportunities. Other of Gundlach’s views are equally visionary: he advocates, for example, abolishing the Fed. Not exactly received wisdom, but Gundlach’s keenness and conviction can make almost any idea interesting.

Gundlach has consciously cultivated a flamboyant style: Mondrian paintings in his office, quotations from the Great Books at meetings, unflagging self-promotion. But these mannerisms are mere epiphenomena of a mind unafraid to voice its ideas, or to call nonsense when it sees it. As such, he is a rare commodity, an American original. Ralph Waldo Emerson: “A man or a company of men, plastic and permeable to principles, by the law of nature must overpower and override all cities, nations, kings, rich men, poets, who are not.”

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Posted by Eddy Elfenbein on April 22nd, 2013 at 11:27 am

 

The information in this blog post represents my own opinions and does not contain a recommendation for any particular security or investment. I or my affiliates may hold positions or other interests in securities mentioned in the Blog, please see my Disclaimer page for my full disclaimer.

Copyright © Crossing Wall Street

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Bill Gross On Why Europe’s Plan “To Get Your Money” Is Doomed

Monday, August 6th, 2012

The very vocal head of the world’s largest bond fund has long been critical of the global ponzi system better known as the “capital markets.” Now, finally, he shifts his attention to Europe, where the interests of his parent – Europe’s largest insurance company Allianz are near and dear to the heart, and deconstructs not only the biggest challenge facing Europe: getting access to your money, but also the fatal flaws that will make achieving this now impossible. To wit: “Psst! Investors – do you wanna know a secret? Do you wanna know what Angela Merkel, François Hollande, Christine Lagarde and Mario Draghi all share in common? They want your money!” …. but… “private investors are balking – and for what it seems are good reasons – because policy makers’ efforts have been, until now, a day late and a euro short, or more accurately, years late and a trillion euros short.” And so they will continue failing ever upward, as permissive monetary policy which allows failed fiscal policy to be perpetuated, will do nothing about fixing the underlying problems facing the insolvent continent. Then one day, the ECB, whose credibility was already massively shaken last week, will be exposed for the naked emperor it is. Only then will Europe’s politicians finally sit down and begin doing the right thing. It will be too late.

From the FT:

Draghi and friends just want your money

Psst! Investors – do you wanna know a secret? Do you wanna know what Angela Merkel, François Hollande, Christine Lagarde and Mario Draghi all share in common? They want your money!
They’ve wanted it for years now but you are resisting by holding on to it or investing it at negative interest rates in Switzerland, Germany and a growing number of other countries considered to be European Union havens. They want you to be less frugal and more risk-seeking. They want your money as a substitute for theirs in Spain, Italy and, of course, Greece, but they don’t mention that any more. The example would be too off-putting. “Investors,” they plead, “show us your money!”

The ultimate goal of monetary and fiscal policy in the EU is to re-engage the private sector. The EU needs the private sector as a willing (but not necessarily equal) partner in funding its economy. This often gets lost in the noisy details of all too frequent promises such as the one to defend the euro made by Mr Draghi, European Central Bank president.

Investors get distracted by the hundreds of billions of euros in sovereign policy checks, promises and IOUs that make for media headlines but forget it’s their trillions that are the real objective. Even Mr Hollande in left-leaning France recognises that the private sector is critical for future growth in the EU. He knows that, without its partnership, a one-sided funding via state-controlled banks and central banks will inevitably lead to high debt-to-GDP ratios, rating service downgrades and a downhill vicious cycle of recession.

But private investors are balking – and for what it seems are good reasons – because policy makers’ efforts have been, until now, a day late and a euro short, or more accurately, years late and a trillion euros short. Let’s look at some examples of this.

First, Greek bailouts that included private sector involvement but no official sector involvement, resulting in the inevitable investor conclusion that future programmes for Spain and Italy might resemble the same.

Second, an initial tightening and then a reluctant lowering of ECB policy rates.

Third, a bond purchase programme (securities markets programme or SMP) by the ECB that was too small and prematurely abandoned.

Fourth, fiscal austerity packages for individual countries that accelerated recessionary/depressionary growth paths.

Fifth, public fights among northern and southern EU countries that highlighted the seemingly perpetual dysfunctionality of the eurozone 17 and the EU 27.

Finally, Mr Draghi’s reversal last Thursday. Someone must have got to him between London and Frankfurt.

Policy makers now face an unprecedented expansion of risk spreads and credit agency downgrades which almost guarantee that sickbed countries can never be discharged from intensive care.

Investors misguidedly focus on 7 per cent yields in Spanish and Italian bond markets as some sort of high watermark – below which swimmers can safely touch bottom. But even at 7 per cent deep, the toes cannot stretch. Maybe even 4 per cent is not shallow enough.

Interest rates over and above each country’s nominal GDP growth rate will inevitably add to a country’s debt as a percentage of GDP, even if budgets are in primary balance.

At current yields, growth rates, and deficits, the spread may incrementally add 2-3 per cent to Spain and Italy’s tenuous debt ratios every year. While it is true that both countries can shorten maturity offerings and even accept the benefit of prior terming of their debt stock, eventual drowning will occur even at 4 per cent or higher 10-year yields as long as nominal GDP growth is anywhere close to flat.

Policy makers will solicit the private market’s participation in an effort to get there, by attempting to lead via co-ordinated monetary/fiscal efforts involving the SMP from the ECB and hundreds of billions of euros from bailout funds – the European Financial Stability Facility and ultimately the European Stability Mechanism. But without the private sector’s co-operation, the effort may be futile.

The dirty little secret that sovereign debt issuing nations need to remember most of all is that credit and maturity extension is based upon trust. After all, “credere” is a Latin word meaning just that. After trust has been lost due to half-baked policy measures; after credit agencies belatedly have recognised embedded costs of debt that can no longer insure solvency; after marginal investors have been flushed from the system to what appear to be safer return of principal havens; and after policy makers finally appreciate the fragility of their rigged fiscal and monetary system; after all of that – there is no coming home, there is no going back in the water.

Psst investors: Stay dry my friends!

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Bond Model: Sell Signal

Sunday, July 15th, 2012

 

by Guy Lerner, The Technical Take

Our bond model has issued a sell signal.

The bond model is based upon intermarket variables including inputs from commodities and utilities.  The model first issued a buy signal on March 30, 2012.  Since that time the Vanguard Total Bond Market Fund (symbol: BND) is up 1.9%.  This ETF also closed at a new all time high on Friday.  The i-Shares Lehman 20 + Year Treasury Bond Fund (symbol: TLT) is up 15% since March 30, 2012.  The out performance of TLT is thought to be due to Operation Twist, as the Federal Reserve has been actively buying at the long end of the yield curve to push down interest rates.  From March 30, 2012 to July 14, 2012, the SP500 loss 3.7%.

It has been my contention that the buy signal back in March was an early sign of economic weakness.  This has turned out to be the case over the past 3 months as important data inputs, like ISM and unemployment,  have been softer than expected.  I don’t believe we are in recession (personal data), and at best, the US economy has stabilized with growth being below trend.

From a technical perspective, TLT looks like one of the best charts in my Chart Book.  See figure 1, a weekly chart.  Price must remain above the 128.52 key pivot point (support level) to avoid being a double top.  Considering that our fundamental model has issued a sell signal, I would suspect TLT will struggle going forward.

Figure 1. TLT/ weekly

 

Copyright © The Technical Take

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Is High Yield Right For You?

Saturday, July 14th, 2012

 

by Matt Tucker, iShares

There’s been much ado about high yield bond ETFs in the media for a while now. And with good reason – after a six month stint as the asset class of choice for yield-hungry investors, these funds have been riding a roller coaster of late, making headlines for everything from large redemptions to record trading volume. With the story changing almost weekly, I think it’s a good idea to step back and ask a more fundamental question: what role does high yield play in an investor portfolio?

It’s an interesting question, particularly because with the introduction of high yield ETFs investors now have a new way of accessing the market. High yield ETFs have brought liquidity, transparency, and access to a market that was previously opaque and difficult to access for many investors, and today have grown to thirteen funds and $26 billion in assets globally. Choice is a good thing, but as always investors should consider their own portfolio needs before investing in any asset class or sector.

So what are the considerations for investing in high yield bonds? The obvious attraction is yield, particularly for income seeking investors battling with a prolonged low interest rate environment. The iShares iBoxx $ High Yield Corporate Bond Fund (ticker: HYG) has a 30-Day SEC yield of 6.65% (as of 7/9/12) However, it’s important to note that this yield comes at a price – namely, higher credit risk than most fixed income securities, and therefore a higher risk of default. It’s this perilous reputation that earned them the moniker “junk” bonds.

Despite the negative connotations, it’s important to remember that junk bonds are still bonds, and that means that they are generally less risky than equities (see below). This simple point is often misunderstood by many investors. High yield debt issuance has a higher claim on assets than equity issuance, which means that if a firm faces bankruptcy, the bond holders get paid before the equity investors. We’ve actually seen clients shifting their dividend-paying equity allocations into high yield for just this reason, as a way to reduce risk and boost income.

Of course, more risk also equates to higher expected returns. What’s interesting to me is how these different asset classes deliver return to investors. When an investor moves from Treasury bonds to investment grade corporates, they are taking on an increasingly high level of default risk and are being compensated with higher expected yields. When an investor goes from high yield to developed market equities they actually receive a lower expected yield but a higher expected price appreciation, which results in a higher expected return.

What’s the bottom line for how investors should think about high yield? As an asset class that offers some of the largest yields in fixed income markets high yield can play a role in generating income for a portfolio, but investors should be mindful of the increased risk relative to many other fixed income sectors. High yield’s best role is as a source of income in a broadly diversified portfolio.

Source: Bloomberg

Matt Tucker, CFA is the iShares Head of Fixed Income Strategy and a regular contributor to the iShares Blog. You can find more of his posts here.


Bonds and bond funds will decrease in value as interest rates rise. High yield securities may be more volatile, be subject to greater levels of credit or default risk, and may be less liquid and more difficult to sell at an advantageous time or price to value than higher-rated securities of similar maturity.
For HYG standardized performance, please click here

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When To Consider Getting Aggressive in High Yield

Thursday, July 5th, 2012

 

by Russ Koesterich, Chief Investment Strategist, iShares

Here’s my take: I believe high yield bonds are close to fair value, I hold a neutral viewof the asset class and I advocate that investors generally maintain a benchmark weight.

That said, in the following three instances, I’d advocate investors consider being more aggressive buyers of high yield:

1.) If spreads widen. The spread between high yield bonds and the 10-year Treasury has generally fluctuated between 500 to 600 basis points this year, about where high yield should trade given the sluggish economic environment. However, assuming no further deceleration in the US economy, any further widening of high yield spreads back toward a premium of 650 to 700 basis points over the 10-year Treasury would represent a good buying opportunity, especially considering that many corporate balance sheets generally have been extremely strong and default rates have been low.

2.) If they have portfolios with high income needs. With a yield to maturity a little under 7% and volatility of less than 10%, a fund like the iShares iBoxx $ High Yield Corporate Bond Fund, (NYSEARCA: HYG) is an efficient way to add incremental yield to a portfolio. As such, investors may want to consider adding high yield bonds to their fixed income portfolios as their demand for income rises. For instance, while risk adverse investors may only want to hold around 10% of their fixed income portfolios in high yield, investors willing to take incremental risk to earn additional income may want to consider holding as much as 30% of their fixed income portfolio in high yield.

3.) If they are worried about rising rates. Investors who are worried about rising interest rates may also want to add high yield as a substitute for long-dated Treasuries. High yield bond funds currently have lower durations than Treasury funds, meaning that Treasuries are far more sensitive to interest rates. If interest rates rise even modestly, Treasury funds are likely to suffer larger losses than high yield bond funds.

Source: Bloomberg, iShares.com

Russ Koesterich, CFA is the iShares Global Chief Investment Strategist and a regular contributor to the iShares Blog. You can find more of his posts here.

The author is long HYG


 
The performance quoted represents past performance and does not guarantee future results. Investment return and principal value of an investment will fluctuate so that an investor’s shares, when sold or redeemed, may be worth more or less than the original cost. Current performance may be lower or higher than the performance quoted. Performance data current to the most recent month end may be obtained by calling toll-free 1-800-iShares (1-800-474-2737) or by visiting www.iShares.com. For standardized performance for HYG, please click here.
Bonds and bond funds will decrease in value as interest rates rise. High yield securities may be more volatile, be subject to greater levels of credit or default risk, and may be less liquid and more difficult to sell at an advantageous time or price to value than higher-rated securities of similar maturity.

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How Many Times Have We Heard That This is the Death of Bonds?

Friday, June 1st, 2012

 

by Guy Lerner, The Technical Take

I know they don’t move much, but in these turbulent times, just getting your principal back from an investment is a winning proposition.  I have been bullish on bonds since March 30, 2012, and at the time, I suggested that this was an early sign of economic weakness, and on April 23 I wrote: “A topping equity market appears to be a sign of an economy that has peaked as well.  This has been heralded by strength in bonds.  Most likely, this is signaling further quantitative easing as the Federal Reserve intervenes in the bond market to prop up the economy and the equity markets.“

So fast forward to this week, and we note the following.  The calls for the death of bonds has been pre-mature.  Once again!  How many times have we heard this over the past several years?  Yes, they are boring, and yes, the market is very distorted courtesy of the Federal Reserve.  But since April 30, the Vanguard Total Bond Market ETF (symbol: BND) is up 1.42% while the SP500 is down nearly 7%.  The i-Shares Lehman 20 + Year Treasury Bond Fund (symbol: TLT) is up nearly 13% in this time period.  Of course, hindsight being nearly 20/20, this suggests the Fed is continuing its purchases at the long end of the curve, and in all likelihood, the next round of quantitative easing will target these maturities as well.

For the record, figure 1 is a weekly chart of the TLT.  Note the breakout to new all time highs.  Even to the equity bulls this must mean something.  Right?

Figure 1. TLT/ weekly

 

Copyright © The Technical Take

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Proceed With Caution in the Hunt for High Yield

Tuesday, April 3rd, 2012

Given high yield credit’s recent rally and surge of inflows, I’m now getting a lot of questions about whether or not the asset class still looks appealing.

While high yield provides an attractive pickup in yield and I’m maintaining my neutral view of the sector, I believe the easy money has probably already been made and the asset class no longer looks cheap. As such, over high yield, I prefer investment grade credit and municipals.

As high yield credit is highly correlated with equities, it’s hardly surprising that the asset class has rallied sharply since fall lows, taking part in the strong rebound in stocks and other risky assets. The iShares iBoxx $ High Yield Corporate Bond Fund (NYSEARCA: HYG) is up more than 12% from its early October closing low. Past performance does not guarantee future results. For standardized performance, please click here. And of course, this surge in price has been accompanied by a surge in flows. Year to date, $6.5 billion has flowed into high yield exchange traded funds, with half going to HYG.

Following this rally, the yield to maturity for high yield is roughly 7% or nearly a 500 basis point premium to the 10-year Treasury. That’s close to fair value given the following analysis.

When you look at the historical spread between high yield and the 10 year-Treasury, spreads typically tighten as expectations for the economy improve. They widen when investors are worried about a recession and credit quality.  In the past, economic indicators have explained roughly 50% of the variation in where high yield spreads relative to Treasuries, testifying that the economic situation has been a key driver of spreads LQDhistorically.

A comparison of high yield spreads with leading indicators today suggests that high yield should be yielding roughly 500 bps more than the yield on the 10-year Treasury, fairly close to current levels.

To be sure, I don’t believe investors should avoid high yield. Investors in high yield are still picking up significant incremental yield, and given strong corporate balance sheets, I don’t expect any significant pickup in default rates. But as the asset class no longer appears as inexpensive as it was last fall, I wouldn’t advocate aggressively putting new money to work in high yield.

Instead, I prefer investment grade and high quality municipals. I hold overweight views of both asset classes, which still appear relatively cheap versus Treasuries. Take investment grade credit, which is a nice substitute for those looking to lower their exposure to Treasuries. While high yield spreads have contracted by 250 bps since last fall, spreads for investment grade credit have not come in nearly as much.

Investors can access investment grade credit through the iShares iBoxx $ Investment Grade Corporate Bond Fund (NYSEARCA: LQD) and they can access municipals through the iShares S&P Short Term National AMT-Free Municipal Bond Fund (NYSEARCA: SUB) and the iShares S&P National AMT-Free Municipal Bond Fund (NYSEARCA: MUB).

 

Source: Bloomberg

The author is long LQD and MUB

The performance quoted represents past performance and does not guarantee future results. Investment return and principal value of an investment will fluctuate so that an investor’s shares, when sold or redeemed, may be worth more or less than the original cost. Current performance may be lower or higher than the performance quoted. Performance data current to the most recent month end may be obtained by calling toll-free 1-800-iShares (1-800-474-2737) or by visiting www.iShares.com.

Bonds and bond funds will decrease in value as interest rates rise. High yield securities may be more volatile, be subject to greater levels of credit or default risk, and may be less liquid and more difficult to sell at an advantageous time or price to value than higher-rated securities of similar maturity. A portion of a municipal bond fund’s income may be subject to federal or state income taxes or the alternative minimum tax. Capital gains, if any, are subject to capital gains tax.

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David Rosenberg: The Truth On Sideline Cash

Wednesday, March 21st, 2012

The money-on-the-sidelines argument has reached deafening and self-confirming as anchoring bias among any and every swollen long-only manager seems to have made them ignore the realities of the situation. David Rosenberg, of Gluskin Sheff to the rescue with good old fashioned facts – as much as they might disappoint the audience. Barton Biggs quote in the USA Today article points out how bullish he is and how cash levels are very high and “idled money is ready to be put to work”. However, as Rosie points out equity fund cash ratios are at a de minimus 3.6%, the same level as in the fall of 2007 and near its lowest level ever. The time when cash was heavy and ‘ample’ was at the market lows in 2009 when the ratio was very close to 6%. Bond fund managers, it should be noted this includes the exuberant HY funds, are now sitting on less than 2% cash so if retail inflows continue to subside as they did this week, buying power could weaken over the near-term. What David points out that is more interesting perhaps is the converse of most people’s contrarian dumb money perspective – the household sector appears to have used the rally of the past three years, for the most part, to diversify out of the equity market (getting out at price levels they could only dream of seeing again). As we have pointed out again and again, the retail investor has been a net redeemer in equity funds for nine-months running and has been rebalancing since the March 2009 lows in a clearly demographic shift towards income strategies as the memory of two bursting bubbles within seven years is seared into most private investors’ minds.

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Bond ETF Idea: High Credit Quality Bonds (Tucker)

Monday, March 12th, 2012

First, the bad (and obvious) news: When it comes to investing, you can’t control returns.  Now, the good news: You can manage the amount of risk in your portfolio, and managing risk is one way of influencing returns.

Take, for example, the investment grade corporate bond space, which consists of bonds rated AAA all the way down to BBB-.  Until recently, most pooled investment vehicles such as ETFs and mutual funds offered investment grade access based on this typical definition.  With last month’s launch of the iShares Aaa-A Rated Corporate Bond Fund (NYSE Arca: QLTA), investors now have a tool for targeting a specific amount of credit risk within their fixed income investments and, more specifically, can eliminate exposure to BBB-rated bonds.

Why would an investor want to slice and dice the corporate bond space using credit quality?  I frequently speak with clients that have mandates that stipulate a minimum credit quality of A or higher for their bond portfolios. Just as many insurance companies and public unions have this requirement either by law or as a part of their investment policy statements, so do many individual investors feel generally uncomfortable with lower credit quality.  For both groups, QLTA provides the ability to stay at the upper tier of the quality spectrum, while also offering diversified exposure across sectors and maturities.

Because of the reduced exposure to lower rated bonds, there is a tradeoff in yield vs. broader indices (see graph below).  But the benefit of QLTA is that it allows investors to quantify what that tradeoff is worth.

We typically see clients using this in one of two ways.  First, as a complement to their broad corporate bond exposure (for example, the iShares iBoxx $ Investment Grade Corporate Bond Fund; NYSE Arca: LQD).  AAA to A bonds comprise about 71% of LQD, which means that 29% is BBB-rated bonds.  Adding an allocation to QLTA can tilt overall exposure toward the higher quality end of the spectrum.  And second, investors who are allocating their equity exposure to high quality companies can now take similar positioning in their fixed income portfolio.

* Index data for High Yield, Investment Grade Corporate and Corporate AAA-A. These are iBoxx $ Liquid High Yield Index, iBoxx $ Liquid Investment Grade Index and the Barclays Capital US Corporate Aaa – A Capped Index. Index constituents are subject to change.

Index returns are for illustrative purposes only and do not represent actual iShares Fund performance. Index performance returns do not reflect any management fees, transaction costs or expenses. Indexes are unmanaged and one cannot invest directly in an index. Past performance does not guarantee future results. For actual iShares Fund performance, please visit www.iShares.com

Bonds and bond funds will decrease in value as interest rates rise. In addition to the normal risks associated with investing, narrowly focused investments typically exhibit higher volatility. The Funds are subject to credit risk, which refers to the possibility that the debt issuers may not be able to make principal and interest payments or may have their debt downgraded by ratings agencies. High yield securities may be more volatile, be subject to greater levels of credit or default risk, and may be less liquid and more difficult to sell at an advantageous time or price to value than higher-rated securities of similar maturity. Diversification may not protect against market risk.

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Bond ETF Idea: Commercial Mortgage Backed Securities

Tuesday, March 6th, 2012

by Matt Tucker, Managing Director, Fixed Income,  iShares

ABS, MBS, CMBS.  Navigating your way around the various fixed income sectors can sometimes feel like a bowl of alphabet soup.  And with the proliferation of fixed income ETFs giving investors more ways than ever to slice and dice the bond market, now’s a great time to brush up on your acronyms.

Take, for example, commercial mortgage-backed securities (CMBS).  CMBS are fixed income securities that are backed by loans on things like office buildings, retail properties, and hotels.  The sector currently represents about 2% of the US fixed income market.

For investors who have a positive view on the commercial real estate market, CMBS are a way to gain exposure with less risk than real estate investment trusts (REITS).  Since its inception six years ago, the Dow Jones US REIT Index has experienced volatility of 30.1% and a return of 2.6%, whereas the Barclays Capital US CMBS Index experienced a volatility of 13.3% and a return of 6.63% during the same timeframe.  Keep in mind that REITS are equity securities, whereas CMBS are debt securities.

CMBS also have a compelling income component – compared to sectors that have a similar duration (a measure of bond risk), investment grade CMBS are currently offering a higher yield.  Note that in the chart below, CMBS is represented by the Barclays Capital US CMBS Index, which only includes investment grade bonds – there are no subprime bonds in the index.

Fixed Income Sector Comparison

With the recent launch of the iShares Barclays CMBS Bond Fund (NYSE Arca: CMBS), the first ETF dedicated solely to CMBS, investors now have the ability to gain diversified access to this sector in a single trade.  We expect to see clients using this fund in a few different ways.  One idea: if the investor prefers an overweight to CMBS, they can use it to complement a diversified bond index fund (such as the iShares Barclays Aggregate Bond Fund; NYSE Arca: AGG).  Or they may use it in conjunction with other bond index funds to build a customized fixed income portfolio.

 

Source: Bloomberg

Chart Source: Barclays Capital and iBoxx as of 2/21/2012. Past performance does not guarantee future results.  Fixed income sectors are represented by the following indexes –   Barclays Capital U.S. CMBS (ERISA Eligible) Index, Barclays Capital U.S. Agency Index, Barclays Capital 3-7 Year US Treasury Index, Barclays Capital U.S. MBS Index, Barclays Capital Intermediate U.S. Credit Index, iBoxx $ Liquid High Yield Corporate Bond Index, Barclays Capital U.S. Aggregate Index

Bonds and bond funds generally decrease in value as interest rates rise. In addition to the normal risks associated with investing, narrowly focused investments typically exhibit higher volatility. Commercial mortgage-backed securities (“CMBS”) represent interests in “pools” of commercial mortgages and are subject to credit, prepayment and extension risk, and therefore react differently to changes in interest rates than other bonds. Small movements in interest rates may quickly and significantly reduce the value of CMBS. Diversification may not protect against market risk.

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