Investors have been moving toward low-fee, passive investment solutions over the past two decades. As of the end of September, total assets in passive mutual funds and ETFs were nearly $9 trillion, or nearly 42% of all mutual fund and ETF assets. Investors have poured $220 billion into passive fixed-income strategies in the past 12 months with $69 billion flowing into the passive intermediate core bond category alone. The allure of these solutions is obvious: costs matter. The problem, however, is that passive investors are only considering part of the story when they equate costs with fees. By ignoring opportunity cost considerations, passive investors have set themselves up to pay low fees and potentially receive lower returns, therefore paying higher total costs in the end.
It’s been a big week for financial markets with the U.S. election, several central bank meetings—including the Federal Reserve (Fed), and ongoing pressure from COVID-19. The increased prospect of an orderly transfer of presidential power in the U.S. along with a politically divided U.S. Congress, ongoing central bank support, and hopes for a COVID-19 vaccine all conspired to create a surge in riskier assets and a sell-off in low-risk assets. For fixed-income investors, the short takeaway is the pre-election trends of a steeper yield curve, a weaker U.S. dollar, and tighter credit spreads reasserted themselves and are likely to continue into year-end.
Investors looking for tax-exempt income in the municipal fixed-income markets are in a tough bind these days. Highly rated bonds, with very high prices and correspondingly low yields, are “priced for perfection.” Lower-rated bonds, from which investors may be able to source slightly more attractive yields, may be under more credit risk pressure given the pandemic and recession in the United States. The combination of low nominal yields and increasing credit risk puts municipal fixed-income investors in a challenging position.
Money market funds are an important part of the short-term credit markets. That’s why the Federal Reserve (Fed) has been committed to ensuring they operate as they should.
- The amount of global bonds trading at negative yields continues to rise and has accelerated recently.
- There are a number of reasons why investors continue to hold and purchase bonds with negative yields.
- Rate and credit volatility are likely to continue, offering opportunities for active fixed-income investors to source alpha and manage risk.