Investors don’t tend to demand too much from their fixed-income portfolio. Give us a meaningful yield without too much volatility and we’re happy. Recently, however, that has been too much to ask for—not because of the yield, but because of the volatility.
The MOVE Index, a measure of interest-rate volatility, has been running about twice as high over the past two years as it did during the previous two—and at levels not seen since the 2008-09 financial crisis. Witness the swings in the
iShares Core U.S. Aggregate Bond
exchange-traded fund (ticker: AGG), which tracks an index of investment-grade bonds: It ran up about 8% in the last two months of 2023 and is down 2% year to date, mostly due to interest-rate swings.
The good news is that it is possible to get high yields and a lot less volatility than the index. Consider the
BlackRock Flexible Income
ETF (BINC), which launched last May and is managed by Rick Rieder, BlackRock’s chief investment officer of global fixed income, a 36-year bond veteran.
Securities held in the actively managed BlackRock ETF’s current portfolio average a 6.9% yield, compared with 5% for the iShares ETF. Since inception, BINC has returned 7.1%, compared with 1.3% for AGG, with about half the volatility. Barron’s asked Rieder how it’s done.
Essentially, Rieder says, he seeks out the asset classes that have the highest yields and represent good values. He dips into riskier areas but keeps the overall portfolio average at an investment-grade rating. “We do stress testing, scenario analysis, and a lot of correlation work,” he says. “Every asset we add to the portfolio, we think about its marginal contribution to risk—how does it play in the sandbox?”
All of that may be easier said than done. But thanks to the transparency of the ETF structure, we can see exactly what he’s up to on the fund’s website.
He has got a lot of investment-grade bonds right now with yields in the mid-5% range. Corporates make up about 22% of assets, equally divided between European and U.S. names. He likes European bonds, which get a yield boost from the currency translation. He expects the European Central Bank to lower interest rates faster than the Federal Reserve. (Bond prices move inversely to yields.) He expects the Fed to start cutting rates around midyear.
A healthy portion of the portfolio is in high-yield bonds—ones rated below investment grade. About 24% of assets are in U.S. junk bonds, along with 14% in Europe. He thinks companies that issue high-yield debt are largely in good shape because many refinanced when rates were low and won’t need to take out a lot of new debt at today’s higher rates soon.
Emerging market debt makes up about 6% of the portfolio. He looks for higher quality and a high-6% range yield in places like Mexico, Brazil, Indonesia, and South Africa. “I find today we don’t need the volatility [of EM] since we’re getting so much yield in developed markets,” he says. “I think EM is going to have a good year, but it does well when the Fed is cutting rates, and this Fed is going to be patient for a bit.”
Securitized products make up 29% of the portfolio and provide yield plus diversification, says Rieder. Examples of these more esoteric securities include collateralized loan obligations and commercial mortgage-backed securities, an area he’s adding to lately due to wider spreads.
A big reason BINC has less volatility is because it takes on less interest-rate risk. The portfolio’s effective maturity is just five years. “We have a flat yield curve today, so the beauty is we don’t have to take on a lot of volatility by going out the yield curve,” says Rieder. “We can get 6.5% to 7% yield and run the portfolio in a pretty stable way.”
To get another percentage point of yield would require taking a lot more risk, he says. “Now we can get into the high 6% yields and sleep really well at night.”
Write to Amey Stone at [email protected]
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