May 11, 2021
Why we favor yield-enhanced fixed-income sectorscall out end call out
Rising long-term Treasury yields in the first quarter triggered a sizable loss in Treasury securities with a maturity of more than 15 yearscall out
We believe the U.S. economy is on track this year for its strongest growth since 1984, when gross domestic product grew at a 7.2% rate. As the economic recovery gathered momentum in the first quarter of 2021, long-term Treasury yields (orange line) rose and returns on long-term bonds (purple) dropped.
Yields jumped after the Democrats’ sweep of two Georgia Senate seats on January 5 — on the prospect of more aggressive fiscal stimulus — and again following President Biden’s signing of the American Rescue Plan on March 11. A first-quarter increase of just under one percentage point in yields left long-term Treasuries with their biggest quarterly loss in 41 years.
What it may mean for investorscall out
We positioned our 2021 fixed-income portfolio guidance for just such a rise in long-term yields by favoring yield-enhanced bond sectors, such as preferred and mortgage-backed securities. We also favor municipal revenue bonds — we anticipate that tax-exempt bonds would likely gain even more support if the Biden administration’s proposed increase to the top individual tax rate takes effect.
Risk Considerationscall out
Each asset class has its own risk and return characteristics. The level of risk associated with a particular investment or asset class generally correlates with the level of return the investment or asset class might achieve. Bonds are subject to market, interest rate, price, credit/default, liquidity, inflation and other risks. Prices tend to be inversely affected by changes in interest rates. Although Treasuries are considered free from credit risk they are subject to other types of risks. These risks include interest rate risk, which may cause the underlying value of the bond to fluctuate. Municipal bonds offer interest payments exempt from federal taxes, and potentially state and local income taxes. Municipal bonds are subject to credit risk and potentially the Alternative Minimum Tax (AMT). Quality varies widely depending on the specific issuer. Municipal securities are also subject to legislative and regulatory risk which is the risk that a change in the tax code could affect the value of taxable or tax-exempt interest income. Mortgage-backed securities are subject to prepayment risk. Changes in prepayments may significantly affect yield, average life and expected maturity of the portfolio. Preferred securities have special risks associated with investing. Preferred securities are subject to interest rate and credit risks. Preferred securities are generally subordinated to bonds or other debt instruments in an issuer's capital structure, subjecting them to a greater risk of non-payment than more senior securities. In addition, the issue may be callable which may negatively impact the return of the security.
An index is unmanaged and not available for direct investment.
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