Home etftrends.com Build Your Core (Portfolio) the Right Way—Part 2

Build Your Core (Portfolio) the Right Way—Part 2

By Behnood Noei, CFA
Director, Fixed Income

Key Takeaways

There is no doubt that fixed income markets have had a challenging start to the year. As of May 10, 2024, the 10-Year Treasury rate stands at 4.49%, an increase of 61 basis points (bps) from the beginning of the year. This is mainly due to the markets’ rethinking of the timing and frequency of the cuts by the Fed in 2024. Sticky inflation, a strong job market and higher-than-expected GDP growth YTD have all had a role in this paradigm shift.

In the face of this environment, the Bloomberg US Aggregate Index (Agg) has posted a YTD return of -3.28% through the end of April. This result could have been even worse if not for resilient credit markets, with most asset classes’ spreads over Treasuries grinding lower and offsetting some of the price sensitivity to interest rate moves.

We wrote about the WisdomTree Yield Enhanced U.S. Aggregate Bond Fund (AGGY) at the end of February and explained how there could be changes made to plain-vanilla, core U.S. aggregate portfolios to benefit from valuations. Since then, AGGY has outperformed the Aggregate Index by 21 bps gross and 18 bps net of fees, respectively. However, the more eye-catching numbers are the YTD numbers. Since the beginning of the year, AGGY has outperformed the Aggregate Index by 56 bps gross and 51 bps net of fees, respectively (as of April 30, 2024). Over the last year, AGGY has outperformed by 1.80% gross of fees and 1.65% net of fees.

For the most recent standardized and month-end performance, please click here.    

Looking forward, we still believe AGGY can continue to outperform the Aggregate Index. This is due to the fact that in addition to all the characteristics outlined in the first part of this blog series, and after almost a year and a half of having a lower duration compared to the Agg, AGGY now has a higher duration and can benefit in most environments in which rates don’t go materially higher from here.

Option-Adjusted Duration

In response to the Federal Reserve’s policy tightening and the resulting inverted yield curve, our quantitative process shifted some of the allocation away from long-duration sectors, such as 30-year conventional mortgage-backed securities (MBS), toward shorter-term sectors, including 1- to 5-year corporate bonds. This reallocation caused the Fund to have a lower duration than Agg’s in the past year and a half. And, as rates rose during this period, the Fund was rewarded handsomely.

However, as corporate spreads have kept grinding lower, the risk-return profile of the long credit sector has become attractive, and as a result, its allocation in the Fund has been on the rise. This has led to AGGY once again having a higher duration than the Agg as of April 30, 2024. As we mentioned earlier, if the market and Fed’s expectations of a lower future path for rates come to fruition, we expect this longer duration will benefit the strategy once again. In conclusion, AGGY has performed well compared to its big brother recently and since its inception. Despite this outperformance, since most of the themes that we outlined in the first part of this blog series at the end of February are still relevant, we believe there is more room for outperformance, and as a result, AGGY should be considered as an integral part of core fixed income investors’ portfolios.

For more news, information, and analysis, visit the Modern Alpha Channel.


Important Risks Related to this Article

There are risks associated with investing, including the possible loss of principal. Fixed income investments are subject to interest rate risk; their value will normally decline as interest rates rise. Fixed income investments are also subject to credit risk, the risk that the issuer of a bond will fail to pay interest and principal in a timely manner or that negative perceptions of the issuer’s ability to make such payments will cause the price of that bond to decline. Investing in mortgage- and asset-backed securities involves interest rate, credit, valuation, extension and liquidity risks and the risk that payments on the underlying assets are delayed, prepaid, subordinated or defaulted on. Due to the investment strategy of the Fund, it may make higher capital gain distributions than other ETFs. Please read the Fund’s prospectus for specific details regarding the Fund’s risk profile.

U.S. investors only: Click here to obtain a WisdomTree ETF prospectus which contains investment objectives, risks, charges, expenses, and other information; read and consider carefully before investing.

There are risks involved with investing, including possible loss of principal. Foreign investing involves currency, political and economic risk. Funds focusing on a single country, sector and/or funds that emphasize investments in smaller companies may experience greater price volatility. Investments in emerging markets, currency, fixed income and alternative investments include additional risks. Please see prospectus for discussion of risks.

Past performance is not indicative of future results. This material contains the opinions of the author, which are subject to change, and should not to be considered or interpreted as a recommendation to participate in any particular trading strategy, or deemed to be an offer or sale of any investment product and it should not be relied on as such. There is no guarantee that any strategies discussed will work under all market conditions. This material represents an assessment of the market environment at a specific time and is not intended to be a forecast of future events or a guarantee of future results. This material should not be relied upon as research or investment advice regarding any security in particular. The user of this information assumes the entire risk of any use made of the information provided herein. Neither WisdomTree nor its affiliates, nor Foreside Fund Services, LLC, or its affiliates provide tax or legal advice. Investors seeking tax or legal advice should consult their tax or legal advisor. Unless expressly stated otherwise the opinions, interpretations or findings expressed herein do not necessarily represent the views of WisdomTree or any of its affiliates.

The MSCI information may only be used for your internal use, may not be reproduced or re-disseminated in any form and may not be used as a basis for or component of any financial instruments or products or indexes. None of the MSCI information is intended to constitute investment advice or a recommendation to make (or refrain from making) any kind of investment decision and may not be relied on as such. Historical data and analysis should not be taken as an indication or guarantee of any future performance analysis, forecast or prediction. The MSCI information is provided on an “as is” basis and the user of this information assumes the entire risk of any use made of this information. MSCI, each of its affiliates and each entity involved in compiling, computing or creating any MSCI information (collectively, the “MSCI Parties”) expressly disclaims all warranties. With respect to this information, in no event shall any MSCI Party have any liability for any direct, indirect, special, incidental, punitive, consequential (including loss profits) or any other damages (www.msci.com)

Jonathan Steinberg, Jeremy Schwartz, Rick Harper, Christopher Gannatti, Bradley Krom, Kevin Flanagan, Brendan Loftus, Joseph Tenaglia, Jeff Weniger, Matt Wagner, Alejandro Saltiel, Ryan Krystopowicz, Brian Manby, and Scott Welch are registered representatives of Foreside Fund Services, LLC.

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