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Being Active in Fixed Income

November 2018

You shouldn’t simply go through the motions at the gym—or with your fixed-income portfolio.


You’ve had the same exercise routine for a while now.

Weight lifting on even days; cardio on the odd.

Just getting through the gym doors is a big win—you’re seeing results simply by going. But what happens when you realize your workout isn’t as effective as it once was—or possibly could be? Sticking to the same old, same old may keep you from seeing greater benefits or potentially cause injuries.

The same could be said about your fixed-income strategy.

Grab your workout gear, and we’ll run through why an active approach in fixed income may make sense today and look at the specific asset classes in which active managers have been able to demonstrate a long-term performance edge.

 

Changes

Our bodies constantly change. Yet, we often don’t factor this into our visits to the gym. You’re probably not as flexible as you were at your physical peak. If you want to increase your flexibility, you can’t keep doing the same stretching exercises you’ve always done and expect better, or even the same, results.

Changes in market conditions over the years may call for similar adjustments. Fixed-income yields and total return also aren’t what they were at their peaks. Traditional core bonds have returned just 3.6% a year on average this decade, which makes this the worst decade for bond investors since the 1960s (FIGURE 1). Investors should expect less generous returns for the foreseeable future. A flexible, active approach can be prudent in this challenging fixed-income environment.

 

Figure 1

Attractive Returns Can Be Hard to Find in a Low-Yield World

Fixed-Income Yields and Total Returns Are Highly Correlated 

Chart is for illustrative purposes only. Past performance is not a guarantee of future results.  Investors cannot invest directly in an index.

*Fixed income is represented by Ibbotson Associates US SBBI IT Government USD Index from 1926 to 1975 and Bloomberg Barclays US Aggregate Bond Index from 1976 to 2018. Data Source: Morningstar, 6/18. Please see representative index definitions below.

 

Help!

Your friend at the gym decides it’s time for some assistance. She turns to an experienced trainer with a proven history of results to develop a new personalized workout routine for her.

Signing up with a mutual fund run by an active manager can be similar. They can help create the potential for better outcomes. Active managers often outperformed the median returns of their passive peers (FIGURE 2) in several fixed-income categories over different time periods.

 

Figure 2

Active Fixed Income Offers a Chance at Outperformance

% of Fixed-Income Active Mutual Funds and Active ETFs Outperforming the Median Returns of Their Passive Peers (Net of Fees): Fixed-Income Subsectors (as of 9/30/18)

Data Source: Morningstar, 10/18. Past performance is not indicative of future results. Performance above is based on institutional share class performance and ETF performance using Morningstar categories. Methodology: We calculated the median return for all passive funds and passive ETFs, then calculated the percentage of active funds and active ETFs that outperformed the passive median return. Ten-year data is not available for a passive bank loan strategy.

 

Fitter, Happier

After each successive holiday season, the numbers on the scale go up much quicker than you once remembered. A nutritionist can help you adjust your diet to compensate for extra calories and plan your workouts before you pack on the pounds.

Likewise, with interest rates steadily rising over the past few years, investors wonder how to factor that into their fixed-income strategy. The 10-Year Treasury’s dramatic rise in yield (it’s more than doubled since its 1.36% low in July 2016) is causing turbulence across the fixed-income landscape (FIGURE 3). That’s why active managers strive to anticipate and adapt to changing interest-rate environments.

 

Figure 3

Interest Rates Are Rising More Quickly Than Many Expected 

10-Year Treasury Yield Has Spiked Dramatically (1/4/16-9/30/18)

Data Sources: Federal Reserve Bank of St. Louis, 10/18.

 

Managing Risk

The pain in your lower back or that soreness in your right knee wasn’t there just a few years ago. You’re not a 20-something anymore. But you push yourself like you’re younger. You’re endangering yourself by not understanding the risks for serious injury. The personal trainer your friend works with could help increase your flexibility to prevent an injury.

The same is often true for fixed-income investors. They’re investing in the same bonds they always have. Yet, the level of sensitivity to interest rates (as measured by duration)1 is not now at it’s highest level in 40 years (FIGURE 4). Active managers can help adjust a fund to take all of these risks into account.

 

Figure 4

Duration Risk Is Rising

Duration of the Bloomberg Barclays US Aggregate Bond Index (1/1/78-9/30/18)

Data Source: Barclays Live, 10/18. For illustrative purposes only.

 

Different Strokes for Different Folks

The weight-lifting belt wearers who grunt as they drop dumbbells. The teen who texts while on the treadmill. The couple that stands around and never actually exercises. The reasons they go to the gym may be much different than yours. You shouldn’t follow the workouts of others. They may be at the gym for purposes other than staying fit.

Similarly, investment returns are not the main focus for the world’s largest bond buyers (FIGURE 5). They’re a secondary consideration for many of these long-term bond buyers. Yet, passively investing can mirror the goals of the big bond buyers, not yours. Active managers can help keep you on track. They pursue investment returns in places where some of the world’s largest bond buyers aren’t looking.

 

Figure 5

These Investors Own Approximately 37% of the World’s Bond Supply

Data Sources: The Federal Reserve, Haver Analytics, Bloomberg, Yardeni Research, Insurance Europe, NAIC, and Factset. Data for Top 4 Central Banks as of 2/28/18. Data for US & European Banks as of 1/31/18. Data for US & European Insurers as of 12/31/16. Most recent data available.

 

Finding a Well-Rounded Approach

We all know those gym goers who only work on their arms. By concentrating entirely on the upper body, they have biceps and triceps that we covet. But everything else about them looks out of proportion. These guys with skinny legs put too much focus on building up their arms and neglect to strengthen anything else while lifting.

Investing mostly in US debt is like the weight lifters who only want to go to the “gun show.” Many US fixed-income benchmarks are highly concentrated in US debt. The Bloomberg Barclays US Aggregate Bond Index has 75% exposure to US government-backed debt (FIGURE 6). As a result, some passive fixed-income investors may be exposing their portfolios to significant interest-rate risk. Active managers can reduce this risk by investing in opportunities beyond US debt.

 

Figure 6

Benchmark Breakdown: Bloomberg Barclays US Aggregate Bond Index (as of 9/30/18)

Data Source: Barclays Live, 10/18.

 

Identifying a Problem

You pulled a hamstring doing leg curls last month, but you aren’t quite sure of the injury’s severity. You stick with your regular routine and put further strain on it—until it finally tears. A professional trainer at the gym may have identified the injury and adjusted your workout before you really did severe damage. In the same way, indexes and passive funds often aren’t able to sell downgraded bonds until after they’ve fallen in price. Active managers strive to identify deteriorating credit through fundamental research, which often allows them to exit bond positions before the price deteriorates.

 

Figure 7

Rigid Credit Downgrade Rules Are a Headwind for Passive

Bloomberg Barclays US Investment-Grade Corporate Index Downgrade Cycle

Data Source: Wellington Management, 10/18. Please see representative index definitions below. *Downgrades occur when 2 out of the 3 credit agencies downgrade a bond

 

More Than the Basics

A 30-minute circuit training loop at your gym offers the exercise essentials. Its easy-to-use step-by-step configuration lets you do the basic workout machines and cardio stations in a quick half-hour. You’re missing out on all of the different exercises located just outside the circuit.

Similarly, passive investing in core benchmarks can give you just the fundamentals. Active managers often have the flexibility to add to core fixed-income holdings as they pursue attractive returns. Out-of-benchmark allocations can be a potential source. Adding 20% off-index allocations to the Bloomberg Barclays US Aggregate Bond Index historically boosted returns and enhanced diversification (FIGURE 8).

 

Figure 8

Out-of-Benchmark Allocations Can Be a Potential Source of Attractive Returns

A Hypothetical Core-Plus Approach Performed Better Than a Core Approach
(%) Returns as of 9/30/18

Data Source: Morningstar, 10/18.

 

The Balance

Too much cardiovascular training, but not enough weights. Too much weight training, but not enough cardio. Finding the right balance in your routine is key since each type of workout plays a unique role in keeping you physically fit.

Different components of fixed-income investing also have unique roles to play. Instead of weights and cardio, we have volatility dampeners and income generators. Each serves a unique role in balancing out and diversifying a portfolio. Higher-yielding investments can provide income, but they may unintentionally decrease the diversification benefits of bonds.

 

Figure 9

Fixed Income Can Play Unique Roles in a Portfolio
Historical Equity Correlations vs. Yield (9/30/18)

Past performance does not guarantee future results. Asset classes are represented by the following indices: Bank loans (S&P/LSTA Leveraged Loan Index). Corporate High Yield (Bloomberg Barclays US Corporate High Yield), Emerging Market Debt (Bloomberg Barclays Emerging Markets USD Aggregate Index), Global High Yield (Bloomberg Barclays Global High Yield Index), Core Bonds (Bloomberg Barclays US Aggregate Bond Index), Investment Grade Corporates (Bloomberg Barclays US Corporate Investment Grade). Short-Term Bonds (Bloomberg Barclays US 1-3 Year Gov’t/Credit Bond Index). US Treasuries (Bloomberg Barclays 7-10 Year US Treasury Bond Index), World Bonds (FTSE World Government Bond Index). Data Sources: Barclays Live, Morningstar, 10/18. For illustrative purposes only. 

 

You Can Do It

Sticking with the same old workout or fixed-income investing approach may not be the best way to achieve an optimal outcome in either area. Attractive returns can be hard to find in a low-yield world. Rising rates only further complicate the situation. The actively managed fixed-income ETFs and highly rated mutual funds below may be just what the trainer ordered to help get your portfolio back into shipshape.

 

Morningstar 4- and 5-Star Rated Fixed-Income Funds*

September 30, 2018

  Morningstar Category Overall Rating Cat. Size 3 Year Rating Cat. Size 5 Year Rating Cat. Size 10 Year Rating Cat. Size
Fixed-Income Funds (Class-I Ticker)                  
Hartford Floating Rate (HFLIX) Bank Loan
★★★★ 211 4 211 4 184 3 81
Hartford Floating Rate High Income (HFHIX) Bank Loan
★★★★
211 5 211 4 184 - -
Hartford Municipal Income (HMKIX) Muni National Interm ★★★★ 260 4 260 -
-
-
-
Hartford Municipal Opportunities (HHMIX) Muni National Interm
★★★★★ 260 4 260 4 224 5 146
Hartford Municipal Short Duration (HSDIX) Muni National Short
★★★★ 180 4 180 -
-
- -
Hartford Short Duration (HSDIX) Short-Term Bond ★★★★ 474 4 474 4 400 4 260
Hartford Strategic Income (HSNIX) Multisector Bond ★★★★ 278 4 278 4 215 3 132
Hartford Schroders Tax-Aware Bond (STWTX) Muni National Intermediate ★★★★★ 260 4 260 5 224 - -
Hartfound Total Return Bond (ITBIX) Intermediate-Term Bond ★★★★ 902 4 902 4 796 3 577
Hartford World Bond (HWDIX) World Bond ★★★★ 261 3 261 4 246 -
-

*View the full list of Hartford Funds here.

Performance data quoted represents past performance and does not guarantee future results. Other share classes may have different ratings. The Morningstar RatingTM for funds, or “star rating”, is calculated for funds and separate accounts with at least a 3-year history. Exchange-traded funds and open-ended mutual funds are considered a single population for comparative purposes. Star rating based on a Morningstar Risk-Adjusted Return measure that accounts for variation in a managed product’s monthly excess performance (without adjusting for any sales load, if applicable), placing more emphasis on downward variations and rewarding consistent performance. 5 stars are assigned to the top 10%, 4 stars to the next 22.5%, 3 stars to the next 35%, 2 stars to the next 22.5%, and 1 star to the bottom 10%. Overall Morningstar Rating is derived from a weighted average of the performance figures associated with its 3-, 5-, and 10-year (if applicable) Morningstar Rating metrics. For more information about the Morningstar Fund Ratings, including their methodology, please go to global.morningstar.com/managerdisclosures. © 2018 Morningstar, Inc. All rights reserved. The information contained herein: (1) is proprietary to Morningstar and/ or its content providers; (2) may not be copied or distributed; and (3) is not warranted to be accurate, complete or timely. Neither Morningstar nor its content providers are responsible for any damages or losses arising from any use of this information.

The Hartford World Bond Fund (the “Fund”) has been developed solely by Hartford Funds. The Fund is not in any way connected to or sponsored, endorsed, sold or promoted by the London Stock Exchange Group plc and its group undertakings (collectively, the “LSE Group”). FTSE Russell is a trading name of certain of the LSE Group companies. All rights in the FTSE World Government Bond Index (“WGBI” or the “Index”) vest in the relevant LSE Group company which owns the Index. FTSE Russell® is a trade mark of the relevant LSE Group company and is used by any other LSE Group company under license. The Index is calculated by or on behalf of FTSE Fixed Income, LLC or its affiliate, agent or partner. The LSE Group does not accept any liability whatsoever to any person arising out of (a) the use of, reliance on or any error in the Index or (b) investment in or operation of the Fund. The LSE Group makes no claim, prediction, warranty or representation either as to the results to be obtained from the Fund or the suitability of the Index for the purpose to which it is being put by Hartford Funds.


1Duration is a measure of the sensitivity of an investment’s price to nominal interest-rate movement. 

2Yield to maturity is the total return anticipated on a bond if the bond is held until it matures.

Bloomberg Barclays 7-10 Year US Treasury Bond Index, includes US Treasury securities with a maturity of 7-10 years.

Bloomberg Barclays Emerging Markets USD Aggregate Index is a hard currency emerging markets debt benchmark that includes fixed and floating-rate US dollar-denomiated debt issued from sovereign, quasi-sovereign, and corporate EM issuers.

Bloomberg Barclays Global High Yield Index is an unmanaged index considered representative of fixed rate, non-investment grade debt of companies in the US, developed markets and emerging markets.

Bloomberg Barclays US 1-3 Year Government/Credit Bond Index is an unmanaged index comprised of the US Government/Credit component of the US Aggregate Index.

Bloomberg Barclays US Aggregate Bond Index is composed of securities from the Barclays Government/Credit Bond Index, Mortgage-Backed Securities Index, Asset-Backed Securities Index, and Commercial Mortgage-Backed Securities Index.

Bloomberg Barclays US Corporate Index is a market-weighted index of investment-grade corporate fixed-rate debt issues with maturities of one year or more.

Bloomberg Barclays US Corporate High-Yield Bond Index is an unmanaged broad-based market-value-weighted index that tracks the total return performance of non-investment grade, fixed-rate, publicly placed, dollar denominated and nonconvertible debt registered with the Securities and Exchange Commission.

Bloomberg Barclays US Corporate Investment Grade Bond Index covers all publicly issued, fixed rate, nonconvertible, investment grade debt.

Bloomberg Barclays US Government/Credit Bond Index is a market-value-weighted performance benchmark for government and corporate fixed-rate debt issues.

FTSE World Government Bond Index is a market-capitalization-weighted index consisting of government bond markets. Country eligibility is determined based on market capitalization and investability criteria. All issues have a remaining maturity of at least one year.

Ibbotson Associates Stocks, Bonds, Bills, and Inflation (SBBI) Intermediate-Term Government Bond Index a broad-based index of US bonds provides a long-time series of bond returns.

JPMorgan GBI-EM Global Diversified Index is a comprehensive global, local emerging-markets index, and consists of liquid, fixed-rate, domestic-currency government bonds.

S&P/Loan Syndication and Trading Association (LSTA) US Leveraged Loan Index is designed to reflect the largest facilities in the leveraged loan market.

This information should not be considered investment advice or a recommendation to buy/sell any security. In addition, it does not take into account the specific investment objectives, tax, and financial condition of any specific person. This information has been prepared from sources believed reliable but the accuracy and completeness of the information cannot be guaranteed. This material and/or its contents are current at the time of writing and are subject to change without notice. This material may not be copied, photocopied or duplicated in any form or distributed in whole or in part, for any purpose, without the express written consent of Hartford Funds.

Important Risks: Investing involves risk, including the possible loss of principal. There is no guarantee a fund will achieve its stated objective. • Fixed income security risks include credit, liquidity, call, duration, and interest-rate risk. As interest rates rise, bond prices generally fall. • High-yield (“junk”) bonds involve greater risk of price volatility, illiquidity, and default than higher-rated debt securities.• Municipal securities may be adversely impacted by state/local, political, economic, or market conditions. Investors may be subject to the federal Alternative Minimum Tax as well as state and local income taxes. Capital gains, if any, are taxable. • Bank loans can be difficult to value and highly illiquid; they are also subject to nonpayment, collateral, bankruptcy, default, extension, prepayment and insolvency risks. • Foreign investments may be more volatile and less liquid than U.S. investments and are subject to the risk of currency fluctuations and adverse political and economic developments. These risks may be greater for investments in emerging markets. • Diversification does not eliminate the risk of experiencing investment losses.

Floating Rate Fund and Floating Rate High Income Fund should not be considered as alternatives to CDs or money market funds. These funds are for investors who are looking to complement their traditional fixed-income investments.

WP457    209463    HFA000406   11/30/19