Global Conservative portfolio positioning intra-quarter update as of 6/8/2022
Increased fixed income duration by trimming short-term corporate exposure and adding long-term corporate and Treasury exposure.
June 8, 2022
Actions and Overview:
Shifted exposure from short-term investment grade credit to long-term investment grade credit and Treasury bonds:
- Trimmed an existing short-term investment grade corporate bond ETF position
- Added to an existing long-term investment grade corporate bond ETF position
- Established a new position in a long-term Treasury ETF
Interest rates have risen sharply over the last two months, reflecting monetary policy tightening expectations and inflation pressures. While we expect economic expansion to continue, we see the U.S. economy slowing toward trend-like growth by the end of 2022 with a high likelihood of inflation rates decelerating. We expect short-term interest rates to rise substantially as the Federal Reserve hikes rates in the near-term, but given our outlook for slowing economic growth and moderating inflation, we believe this will lead to a flattening of the yield curve rather than to substantial further increases in longer-term interest rates. In the two most likely scenarios we see for progression of the cycle, we believe adding to duration (interest rate sensitivity) is warranted:
- Continuation of the Cycle: If the Fed hikes interest rates at a slower than expected pace (the most likely scenario in our view, given slowing growth and inflation), one could expect to see a further rise in real rates tied to ongoing economic growth, but we believe a reduction in inflation should mitigate a rise in nominal interest rates.
- Recession Timing Pulled Forward: Alternatively, if there were an economic downturn in the next 6-18 months, which think unlikely, we would expect interest rates to fall.
These portfolio adjustments have shifted the portfolio’s average duration above the benchmark’s by reducing exposure to short-term bonds, where we see the greatest risk of rising interest rates, and by increasing exposure to long-term bonds, where we see reduced interest rate risk. We retain a significant overweight of corporate credit, which remains the primary driver of our expected fixed income returns, and have modestly increased expected yield.
Reduced short-term fixed income exposure:
- Regardless of the ultimate path of Fed tightening, we expect near-term rate hikes will put significant upward pressure on short-term interest rates, presenting a headwind for lower-yielding short-term fixed income.
Increased long-term fixed income exposure:
- We believe that the risk of a significant further increase in long-term interest rates has been reduced as the economic cycle continues to progress and the Fed has begun its hiking cycle, warranting an increase in exposure to longer-duration fixed income.
- If the Fed raises rates less than expected, longer-term bonds should be more sensitive to a general pullback in rates across the overall yield curve, while also yielding more than short- or intermediate-duration bonds.
- We believe long-term investment grade corporate bonds’ higher yields (vs. Treasury bonds) should benefit the portfolio if long-term interest rates are stable, while ongoing economic growth and corporate financial strength could support a narrowing of credit spreads, which would benefit corporate bond prices.
- The addition of long-term Treasury bond exposure also helps extend the duration of the portfolio, and while our economic outlook remains positive, we believe Treasury bonds should perform well as economic growth decelerates and could significantly outperform if growth slows more than we anticipate.