Introducing the WisdomTree Short Duration Fixed Income Model

harper1
Head of Fixed Income & Currency
kevin-temp2
Head of Fixed Income Strategy
Follow Kevin Flanagan
Chief Investment Officer – Model Portfolios
11/05/2021

This article is relevant to financial professionals who are considering offering model portfolios to their clients. If you are an individual investor interested in WisdomTree ETF Model Portfolios, please inquire with your financial professional. Not all financial professionals have access to these Model Portfolios.

Take a look at the following three charts. The first shows the increasing duration of gross debt in the United States. Gross debt includes government, household and non-financial corporate debt. As a reminder, duration is a measure of the sensitivity of bond prices to changes in interest rates, and it is an inverted relationship—when rates go up, bond prices typically go down. The longer the duration, the more sensitive bond prices typically are to changes in rates.

The second chart is the course of interest rates over the past 12 months, especially in the last three—a steady increase, and one that we believe will continue (with the 10-Year Treasury rate perhaps hitting 1.75%–2.00% by year-end).

The third chart is the current level of investment-grade and high-yield credit spreads—currently trading at multi-year lows.

For definitions of terms in the charts, please visit the glossary.

So, rising rates and tight spreads. What is a poor bond investor supposed to do?

Introducing the WisdomTree Short Duration Fixed Income Model

WisdomTree recently launched a Short Duration Fixed Income Model, designed specifically to reduce interest rate risk while not sacrificing too much in terms of yield, relative to the Bloomberg Barclays U.S. Aggregate Bond Index. It can be used as a stand-alone fixed income model or as a complementary sleeve to an existing fixed income allocation as a means of reducing duration risk without disrupting existing allocations.

We kept it simple and inexpensive—four tickers that provide diversification across sectors while maintaining a low duration profile. While a simple construct, the four underlying Funds incorporate some of our most sophisticated thoughts in balancing income opportunities and the risks they entail—from the fundamental screens within our corporate strategies to the prudent approach for enhancing yield embedded in our short core Fund to our leveraging the deep expertise of the Voya Securitized Debt team in navigating opportunities in the securitized debt markets.

For standardized and month-end performance of the funds mentioned above click here.  

For a prospectus for the funds referenced above click here.

As of September 30, 2021, this Model Portfolio, using the weighted average yield of the four underlying securities (since the Model itself was launched only a short while ago), posted a trailing 12-month yield of 1.99% (with a current yield-to-worst of 1.71%)1, while maintaining an average duration of 3.1 years.

In comparison, the Bloomberg Barclays U.S. Aggregate Bond Index currently has an average duration of 6.71 years and is offering a current yield of 1.56%. The pick-up in yield in the short duration Model reflects that it is taking on more credit risk than the index.

Take a look at the following chart. It shows the marginal increase in realized yield as duration increases. Historically, this relationship was roughly 1:1—a 1% pick up in yield for every additional year of duration. That relationship is now at an historical low. Investors simply are not being rewarded at an appropriate level for taking on additional interest rate risk—especially in an environment where we believe rates will continue to grind higher.

The Trade-Off between Duration and Yield

 

Conclusions

With interest rates likely to move higher and credit spreads historically tight, investors should not be looking to take excessive interest rate risk within their fixed income allocations.

Our new Short Duration Fixed Income Model may be part of the solution. It can potentially help reduce interest rate (duration) risk while generating close-to-index levels of yield.

You can learn more at our Model Adoption Center. We hope you will take a look.

 

 

1 “Yield-to-worst” is a measure of the lowest possible yield that can be received on a bond that fully meets its contractual obligations without defaulting. It takes into account bond provisions that allow the issuer to close out the debt before it matures (two examples are callability and the prepayment option on mortgages). 

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. High-yield or “junk” bonds have lower credit ratings and involve a greater risk to principal. Please read each Fund’s prospectus for specific details regarding the Fund’s risk profile.

For retail investors: WisdomTree’s Model Portfolios are not intended to constitute investment advice or investment recommendations from WisdomTree. Your investment advisor may or may not implement WisdomTree’s Model Portfolios in your account. The performance of your account may differ from the performance shown for a variety of reasons, including but not limited to: Your investment advisor, and not WisdomTree, is responsible for implementing trades in the accounts; differences in market conditions; client-imposed investment restrictions; the timing of client investments and withdrawals; fees payable; and/or other factors. WisdomTree is not responsible for determining the suitability or appropriateness of a strategy based on WisdomTree’s Model Portfolios. WisdomTree does not have investment discretion and does not place trade orders for your account. This material has been created by WisdomTree and the information included herein has not been verified by your investment advisor and may differ from information provided by your investment advisor. WisdomTree does not undertake to provide impartial investment advice or give advice in a fiduciary capacity. Further, WisdomTree receives revenue in the form of advisory fees for our exchange-traded funds and management fees for our collective investment trusts.

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About the Contributors
harper1
Head of Fixed Income & Currency
Rick Harper serves as the Head of Fixed Income and Currency for WisdomTree Asset Management, where he oversees the firm’s suite of fixed income and currency exchange-traded funds.  Rick has over 22 years investment experience in strategy and portfolio management positions at prominent investment firms. Prior to joining WisdomTree in 2007, Rick held senior level strategist roles with RBC Dain Rauscher, Bank One Capital Markets, ETF Advisors, and Nuveen Investments. At ETF Advisors, he was the portfolio manager and developer of some of the first fixed income exchange-traded funds. His research has been featured in leading periodicals including the Journal of Portfolio Management and the Journal of Indexes. He graduated from Emory University and earned his MBA at Indiana University.
kevin-temp2
Head of Fixed Income Strategy
Follow Kevin Flanagan
As part of WisdomTree’s Investment Strategy group, Kevin serves as Head of Fixed Income Strategy. In this role, he contributes to the asset allocation team, writes fixed income-related content and travels with the sales team, conducting client-facing meetings and providing expertise on WisdomTree’s existing and future bond ETFs. In addition, Kevin works closely with the fixed income team. Prior to joining WisdomTree, Kevin spent 30 years at Morgan Stanley, where he was most recently a Managing Director. He was responsible for tactical and strategic recommendations and created asset allocation models for fixed income securities. He was a contributor to the Morgan Stanley Wealth Management Global Investment Committee, primary author of Morgan Stanley Wealth Management’s monthly and weekly fixed income publications, and collaborated with the firm’s Research and Consulting Group Divisions to build ETF and fund manager asset allocation models. Kevin has an MBA from Pace University’s Lubin Graduate School of Business, and a B.S in Finance from Fairfield University.
Chief Investment Officer – Model Portfolios
Scott Welch is the CIO of Model Portfolios at WisdomTree Asset Management, a provider of factor-based ETFs and differentiated model portfolio solutions. In this capacity he oversees the creation and ongoing management of the WisdomTree model portfolio solution set. He is also a member of the WisdomTree Asset Allocation and Investment Committees. Prior to joining WisdomTree, Scott was the Chief Investment Officer of Dynasty Financial Partners, a provider of outsourced investment research, portfolio management, technology, and practice management solutions to RIAs and advisory teams making the move to independence. He remains an outside member of the Dynasty Investment Committee.  He sits on the Board of Directors of IWI, the Advisory Board of the ABA Wealth Management & Trust Conference, and the Editorial Advisory Boards of the Journal of Wealth Management and the IWI Investments & Wealth Monitor. Scott earned a Bachelor of Science in Mathematics from the University of California at Irvine and an MBA with a concentration in Finance from the University of Massachusetts at Amherst.