Bond investors had it relatively easy over the last few years. The Fed brought short-term interest rates to 5.375% to combat inflation and this anchored yields in such a manner that one could earn healthy fixed income returns while taking on little price volatility.

At his August Jackson Hole speech, Fed Chair Jerome Powell indicated the time has come for the Fed to start lowering rates at the September meeting.¹ How fast rates come down is now clearly a function of the underlying trends in the economy and employment, even more than inflation.

Is now the time to add to duration as Fed rate cuts materialize?

WisdomTree collaborated with Bianco Research, one of the leading macro and bond market research firms, to provide a dynamic index-based solution for core bond exposures.

The WisdomTree Bianco Total Return Fund (WTBN) seeks to track the price and yield performance, before fees and expenses, of the Bianco Research Fixed Income Total Return Index.

On a macro basis, Bianco believes the economy is stronger than many fear and that inflation pressures will remain stickier. This could mean the Fed cuts are shallower than many expect and that rates could face some upward pressure at the long end of the U.S. yield curve.

Being dynamic in assessing the underlying direction of yields is becoming more important at this stage in the yield cycle.

WTBN was launched at the end of 2023. In the spring of 2024, as long-term bond rates were rising, staying in short-term instruments provided cushion while taking on duration provided a drawdown.

But now as rates have come down off fears of economic weakness, a broader bond exposure has started to outperform the shortest duration instruments.

To provide appropriate context for considering WTBN's pattern of returns, we looked at:

• The WisdomTree Floating Rate Treasury Fund (USFR): This strategy seeks to track the price and yield performance, before fees and expenses, of the Bloomberg U.S. Treasury Floating Rate Bond Index. Since the credit is that of the U.S. government and the interest rate is reset on a weekly basis, it is a good representation of a widely followed, extremely short duration instrument, the details of which are explained here.
• The iShares Core U.S. Aggregate Bond ETF (AGG): This strategy is designed to track the price and yield performance, before fees and expenses, of the Bloomberg U.S. Aggregate Index. This could be the most widely followed index of the performance of U.S. investment-grade fixed income, and it is one of the largest ETFs in the world on an AUM basis.²

Figure 1: Standardized Performance

Figure 2 provides a good look, going back to the full available history in WisdomTree’s fund comparison tool, at WTBN and shows how the other funds, USFR and AGG, compared.

Figure 2: Gauging When Duration Did (and Didn’t) Work over WTBN’s Live History

Bianco Research uses the following framework to adjust exposures in their index, typically reviewed and adjusted on a monthly basis. These components are the major return drivers of the best fixed income managers, and Bianco Research believes they can accomplish all that traditional active shops do by just allocating their index around these major buckets.

Figure 3: Bianco Research’s Main Levers of Fixed Income Portfolio Management

Currently the index is under-weight in duration, with a 90% duration target of the broader bond market indexes.

Figure 4: The Rationale behind Bianco Research’s Under-Weight Duration Position

When looking at figure 5, there is a discussion of yield curve positioning. To put it simply, the yield curve, looking from left to right can have a slope to it and this slope can shift. As it states in the text of figure 5, based on Bianco Research’s expectations for changes in this shape being what they are, a neutral positioning makes sense, in their view.

Figure 5: The Rationale behind Bianco Research’s “No Yield Curve” Positioning

Figure 6 illustrates that reasoning behind Bianco Research’s under-weight allocation to corporate credit. As stated in the figure, there has been record corporate bond issuance and, in their view, the equity market is overbought. This is telling us that they believe the risks in corporate credit are high relative to the possible expected returns based on current prices.

Figure 6: The Rationale behind Bianco Research’s Under-Weight Allocation to Corporate

The index has a neutral allocation to mortgages, currently split with two different allocations to the mortgage space, the rationale for which is addressed in figure 7.

Figure 7: The Rationale from Bianco Research for a Neutral Allocation to Mortgages

There is a 10% ”out of benchmark” position, meaning in asset classes that are not represented within the Bloomberg U.S. Aggregate Index.

• 5% represents a bullish allocation to the U.S. dollar
• 5% represents an allocation to 0-5 Year U.S. Treasury Inflation Protected Securities (TIPS)

Figure 8 explains the rationale from Bianco Research for these positions.

Figure 8: The Bianco Research Rationale for a 10% Out of Benchmark Position

Beating the Benchmark: Harder in Equity World

Bianco Research believes there is a fundamental difference between bonds and stocks with respect to market cap-weighted benchmarks.

Whereas market cap weighting rewards the big winners in equities, in bonds market capitalization weighting gives the most weight to those lower-quality issuers that need to borrow the most and take on the most debt.

This fundamental difference between what market cap weighting means for equities versus bonds is why more bond managers typically beat broad bond benchmark than in equities.

As bond market uncertainty remains high, we think now is a good time to consider a dynamic index solution like that offered by WTBN.

Figure 9: Additional Information on the Funds Included in This Blog

¹ Source: Jerome Powell, “Reassessing the Effectiveness and Transmission of Monetary Policy,” economic symposium, Federal Reserve Bank of Kansas City, Jackson Hole, Wyoming, 8/23/24. https://www.federalreserve.gov/newsevents/speech/powell20240823a.htm.

² As of 8/26/24, AGG had more than $117 billion in assets under management.