Originally posted on May 19, 2022
Last updated on May 19, 2022
The bond market has not had a consistent trend over the past year, which has created a challenging environment for allocators, leaving many asking, “what should I do with fixed income, duration, rates, credit” entering 2022.
Looking at the 13F flow data we collected over Q1, the answer has partially revealed itself as during the last two quarters as investors /allocators have seen a significant shift in where yields, the fed, and inflation 2021 ended Q4 2021, and where they are today.
Post the introduction of QE, we saw allocators making two decisions as they constructed bond allocation: where to get income, and what is going to be the ballast/air bag that is not correlated to risk asset drawdowns.
Now, with a few quarters of flow data, we were able to see how these decisions were being made and track trends in allocations, additions, and reductions in exposure.
In this article, we’re going to be sharing some of the 13F trends we’ve seen along the yield curve so far this year, as well as the top 10 holders of bank loan and variable rate ETFs in 2022.
By the end of the article, you’ll have a clear understanding of the variable rate ETF landscape.
First, we’ll jump into the trends.
During the quarter, the yield curve moved higher causing core bonds to sell off almost 6% during and high yield bonds drop 5%...concurrently we saw a reduction among the ETFs and CEFs during this past qtr, in particular in where duration played a role such as intermediate term bonds, where flows dropped 7% QoQ, and high yield dropped 11% QoQ.
In aggregate, money was in motion under the surface as we saw those redemptions find their way into other areas within bond sub-asset classes to take advantage of the yield curve shift that we have seen since the beginning of the year and look for income on the front end of the curve.
Unlike the last hiking cycle which was widely telegraphed and gave allocators time, this one is creating very swift directional flows into the front end of the curve. During Q1, this heavily favored floating/ variable rate and shorter duration vehicles via three main sub-asset classes:Bank loans/leveraged loans/CLOS:
These are below investment-grade, senior secured corporate loans that have floating rate coupons linked to the LIBOR, typically 200 – 400 basis points over SOFR/LIBOR.
They exhibit a very low duration and historically have shown positive correlation with inflation and negative correlation with U.S. Treasuries.
For the past three quarters now, we have seen an increase of 10% in net asset flow for each quarter and points to interest rate aversion driving allocation decisions rather than risk aversion. For a great resource on the asset class, MP member Eaton Vance publishes an informative quarterly update.Floating rate notes:
Similar to bank loans, these have near-zero duration risk, and floating coupons. Unlike bank loans, however, they are issued by investment-grade rated companies with lower credit risk, thus lowering the risk of default, but a lower yield as well: typically 25-100 basis points over LIBOR/SOFR. These are different from bank loans, as BlackRock notes in a recent piece.
Ultra Short and Short Duration
These typically invest in investment grade bonds with fixed rates and fixed maturities. Ultra short strategies will keep their duration at one year or below, and short duration will focus on a one- to three-year maturity range.
Over the course of this most recent quarter, the filings showed a 16% increase in asset flow into these two categories combined. In a recent piece, PIMCO illustrated the characteristics and differences between these categories.
The common theme among all of these sub-asset classes is that they remain well placed to deal with the current environment through the combination of their low duration sensitivity, helping to protect against rising bond yields, and a reasonably attractive coupon level that will help mitigate the income erosion effect from inflation.
Finally, as we continue to compile and update this information into our database, Dakota Marketplace, another trend we saw during the quarter was ongoing conversion from mutual funds to ETFs. This year already saw six firms covering sixteen funds have converted with another seven funds on deck.
Below is a sampling of allocators who had positions in these asset classes as reported at the end of Q1 2022.
Yield Curve Graphic showing the change in yields from Q4 21-Q1 2022:
Now that you’ve got a good understanding of what we’re seeing in the market, we’ll get into the top ten owners of bank loan ETFs in 2022.
While the above are the top 10 owners of bank loan ETFs, you can find the complete list, along with other asset class information in our institutional investor database, Dakota Marketplace. If you’re ready to learn more, we’d love to offer you a free trial of Dakota Marketplace.
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