THE CORE CONUNDRUM - Guggenheim Partners
THE CORE CONUNDRUM - Guggenheim Partners THE CORE CONUNDRUM - Guggenheim Partners
alance totaled $4.5 trillion in 2007. By the end of 2012, it had skyrocketed to $11.3 trillion. Yet, it is projected to go even higher – hitting $18.9 trillion by 2022, according to estimates from the Congressional Budget Office. As Treasuries climbed from 19 percent of the core fixed-income universe to 35 percent over the last five years, the marketcapitalization weighted Agg has followed suit. Treasuries currently comprise 37 percent of the Agg, and combined with agency debt, total U.S. government-related debt comprises nearly 75 percent of the Index with a weighted-average yield of 1.6 percent, as of January 31, 2013. Anchored to a benchmark heavily allocated to sectors yielding negative real rates of return has forced investors to reassess the traditional, benchmark-driven approach to core fixed-income management. While historically, core strategies have had negligible exposure to leveraged credit, emerging-market debt, and non-agency structured credit – all of which are typically higher yielding and commensurately, higher risk segments of the fixed-income universe – this aversion to riskier assets appears to be waning given the need for yield. In the next section, we will analyze the strategies being employed to generate yield, as investors adjust to new market realities. Scarcity of Yield across Fixed-Income Landscape Historically Low Yields across Traditional Core Sectors 18% 15% 12% 9% 6% 7.3% 5.0% 5.5% 5.5% 8.0% 7.9% 6.6% 4.5% 3% 1.9% 1.0% 3.3% 1.8% 2.8% 0.9% 2.5% 1.1% 0% Sector Weight Barclays Agg 100.0% ABS 0.4% Municipals 1.4% CMBS 1.8% Corporates 21.6% Treasuries 36.6% Agency MBS 29.4% Agency Bonds 8.9% Historical High Historical Low Current Historical Average With the average yield of the Barclays Agg at 1.9 percent, and 75 percent of the Index allocated to Treasuries, agency MBS, and agency bonds, investors with minimum yield targets have nowhere to hide within the Index and benchmark-driven strategies may continue to fall short of the yield requirements for most institutional investors. Source: Barclays. Data as of 01/31/2013. 6 | THE CORE CONUNDRUM GUGGENHEIM PARTNERS
SECTION 2 Coping with New Market Realities As institutional investors evaluate their need to generate yield, a softening stance toward tracking error appears to be emerging, industry-wide. Traditional yield enhancement techniques, such as increasing duration and lowering credit quality, may boost total returns in the near term, but at what cost? Currently, benign credit conditions may be overshadowing the potentially deleterious, long-term effects of higher credit and interest rate risk. Prioritizing Yield Targets For investors who service their cash liabilities through the income stream generated from their bond portfolios, relative performance to an Index, that finished 2012 with a total return of 4.2 percent and a yield of 1.7 percent, is of secondary importance, and in some cases, inconsequential. For institutional investors, such as insurance companies, pension funds, and endowments, absolute yields and returns are preeminently important. While several prominent pension funds recently lowered portfolio return estimates by 25 to 50 basis points, these diminutive cuts appear largely symbolic in nature as they fail to address the investment shortfall concerns emanating from this persistent, low-rate environment. Despite historically low yields, materially lowering investment return targets is simply not a viable option for particular investor classes. As portfolio return targets remain unhinged from current market yields, many investors have begun assuming increased investment risks. Demand for yield has precipitated a relaxation in underwriting standards and eased the availability of credit. For example, during 2012, the investment-grade and high-yield bond markets set records for issuance. Particularly in the highyield market, there was a significant increase in deals lacking covenant protection; volume from lower-rated, first-time issuers; and aggressive deal structures. The negative, long-term impact of 7 | COPING WITH NEW MARKET REALITIES GUGGENHEIM PARTNERS
- Page 1 and 2: PORTFOLIO STRATEGY RESEARCH | FEBRU
- Page 3 and 4: SECTION 1 The Core Conundrum In an
- Page 5: Assessing the Relative Value of the
- Page 9 and 10: Nominal Total Return Era of “Retu
- Page 11 and 12: through overcollateralization, exce
- Page 13 and 14: Barbell means to structure a portfo
- Page 15 and 16: The Changing of the Guard The Futur
SECTION 2<br />
Coping with New<br />
Market Realities<br />
As institutional investors evaluate their need to generate yield, a softening<br />
stance toward tracking error appears to be emerging, industry-wide.<br />
Traditional yield enhancement techniques, such as increasing duration<br />
and lowering credit quality, may boost total returns in the near term,<br />
but at what cost? Currently, benign credit conditions may be overshadowing<br />
the potentially deleterious, long-term effects of higher<br />
credit and interest rate risk.<br />
Prioritizing Yield Targets<br />
For investors who service their cash liabilities<br />
through the income stream generated from their<br />
bond portfolios, relative performance to an Index,<br />
that finished 2012 with a total return of 4.2 percent<br />
and a yield of 1.7 percent, is of secondary importance,<br />
and in some cases, inconsequential. For<br />
institutional investors, such as insurance companies,<br />
pension funds, and endowments, absolute yields<br />
and returns are preeminently important. While<br />
several prominent pension funds recently lowered<br />
portfolio return estimates by 25 to 50 basis points,<br />
these diminutive cuts appear largely symbolic<br />
in nature as they fail to address the investment<br />
shortfall concerns emanating from this persistent,<br />
low-rate environment. Despite historically low yields,<br />
materially lowering investment return targets is<br />
simply not a viable option for particular investor<br />
classes. As portfolio return targets remain unhinged<br />
from current market yields, many investors have<br />
begun assuming increased investment risks.<br />
Demand for yield has precipitated a relaxation<br />
in underwriting standards and eased the availability<br />
of credit. For example, during 2012, the<br />
investment-grade and high-yield bond markets<br />
set records for issuance. Particularly in the highyield<br />
market, there was a significant increase in<br />
deals lacking covenant protection; volume from<br />
lower-rated, first-time issuers; and aggressive deal<br />
structures. The negative, long-term impact of<br />
7 | COPING WITH NEW MARKET REALITIES GUGGENHEIM PARTNERS
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