Global Balanced Portfolio Positioning Intra-Quarter Update as of 06/06/2019

Shifted Fixed Income Positioning to Increase Duration and Adjust Credit Risk

Recent economic data suggests moderate economic growth is decelerating somewhat and inflation remains persistently below the Fed’s 2% target (even when excluding recent temporary factors).  As a result, upward pressures on interest rates have eased.  These and other factors have reshaped the U.S. Treasury yield curve, which has flattened significantly and, by some measures, inverted.  The current shape of the yield curve is a new development during this economic expansion and, in our view, is unsustainable.  This leads us to believe that either short-term rates will come down (e.g. the Fed may cut its overnight Fed Funds rate), or longer-term rates will rise.

Given the fundamental macro factors described above, we believe the probability of a Fed Funds rate cut has increased.  Therefore, within the Global Balanced fixed-income allocation, we have eliminated the allocation to floating-rate corporate bonds, which have very short durations, and we have added allocations to intermediate-term corporate bonds and longer-term Treasury securities.  These adjustments have increased the duration of the Global Balanced portfolio’s fixed-income allocation, bringing it essentially in line with the strategy’s benchmark, and have tilted the portfolio’s long-term fixed-income exposure toward Treasury securities, which we view as appropriate given the potential for concerns over slowing economic growth to drive a widening of credit spreads.

Eliminated floating-rate corporate bond exposure:  We believe the probability of a rate cut has increased due to the fundamental forces on the intermediate and long end of the yield curve, including increased trade tensions and signs of weakening economic data in the U.S.  Given that floating-rate securities have a rapid reset of yields as short-term interest rates change, their future returns would be negatively impacted by a cut or cuts to the Fed Funds rate.

Added intermediate corporate bond exposure:  The addition of intermediate corporate bond exposure has extended the Global Balanced portfolio’s duration, and reduced the income impact of lower short-term rates, while not significantly increasing interest rate risk if longer-term corporate rate spreads were to widen.  In a scenario where intermediate and longer-term Treasury yields continue to fall, intermediate-term investment-grade corporates could still perform well relative to intermediate Treasury securities, as investment grade corporate bonds continue to offer a significant yield premium to similar maturity Treasury securities.  Additionally, while we do not currently expect that economic deterioration will be severe enough to warrant a significant further widening of credit spreads, intermediate-term corporate bonds would be less negatively impacted by a given increase in credit spreads than longer-term corporate bonds.

Added long-term Treasury bond exposure:  Given our view that the probability of a Federal Reserve rate cut has increased, we believe long-term Treasury bonds would benefit from a parallel downward shift of the yield curve if the Federal Reserve were to cut short-term rates, as investors likely would interpret a rate cut as a signal of increased risk of economic downturn.  The new allocation represents a slight overweight to longer-term Treasury bonds in the Global Balanced portfolio, while leaving the portfolio effectively neutrally-weighted to long-term corporate bonds and bringing the duration of our fixed-income allocation essentially in line with the benchmark.  Long-term Treasury bonds could outperform long-term corporate bonds if interest rates fall broadly across credit qualities, as Treasury securities generally have higher duration (interest rate sensitivity) than corporate bonds of similar maturity, or if credit spreads widen materially in the face of slowing economic growth or a downturn.  We believe this adjustment, in conjunction with the addition of intermediate-term corporate bond exposure, helps balance the potential for a further decline in interest rates against the risk of widening credit spreads.

The most recent complete presentation can be viewed here.
Any portfolio characteristics, including position sizes and sector allocations among others, are generally averages and are for illustrative purposes only and do not reflect the investments of an actual portfolio unless otherwise noted. The investment guidelines of an actual portfolio may permit or restrict investments that are materially different in size, nature and risk from those shown. The investment processes, research processes or risk processes shown herein are for informational purposes to demonstrate an overview of the process. Such processes may differ by product, client mandate or market conditions. Portfolios that are concentrated in a specific sector or industry may be subject to a higher degree of market risk than a portfolio whose investments are more diversified.
Holdings, Sector Weightings and Portfolio Characteristics were current as of the date specified in this presentation. The listing of particular securities should not be considered a recommendation to purchase or sell these securities. While these securities were among WestEnd Advisors’ Global Balanced holdings at the time this material was assembled, holdings will change over time. There can be no assurance that the securities remain in the portfolio or that other securities have not been purchased. It should not be assumed that recommendations made in the future will be profitable or will equal the performance of the securities presently in the portfolio. Individual clients’ portfolios may vary.