A case for getting off the sidelines and into bond ETFs

00;00;00;00 - 00;00;22;29
Aaron Task
History shows that when the US central bank pivots from a hiking cycle to an easing one bond markets tend to do well in the pause period. That's one of the key takeaways from No Time to Yield. A new report from BlackRock.

No Time To Yield. It's a clever title, but what does it mean for bonds if the Fed's pause period goes on longer than anyone expected?

00;00;23;02 - 00;00;35;13
Aaron Task
I’m Aaron Task, Welcome to In The Know.

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Joining me for this episode is Karen Veraa, Head of iShares U.S. Fixed Income Strategy at BlackRock and one of the report's co-authors. Karen, welcome.

00;00;35;15 - 00;00;37;15
Karen Veraa
Thanks, Aaron. Happy to be here.

00;00;37;18 - 00;01;04;07
Aaron Task
So I don't have to tell you that Fed rate cut expectations have changed pretty dramatically since December and even since the Fed's meeting in March. We're now talking here in mid-April, and there is even some talk of possible rate hikes this year.

So, first of all, has anything changed in your market outlook based on the reduced expectations for Fed rate cuts in 2024?

00;01;04;09 - 00;01;25;27
Karen Veraa
So at the beginning of 2024, the market was expecting about five to six interest rate cuts. So moving down from this five and a quarter rate today to 3.75% with a long-term goal of getting down to more like two and a half percent on that overnight rate. Since that time, we've had inflation prints ranging in that three and a half percent range, very strong jobs creation, rising energy prices and housing costs, both in terms of rents and mortgage rates.

So if you couple that with other categories like nichey categories like motor vehicle insurance rising, the Fed still feels like they have their work cut out for them. And the Fed governors have been very vocal about setting expectations for eventual cutting.

So where we are in the market today is we're only pricing in one to three cuts starting in November. And the message is very data dependent. But I don't think this really changes the big picture that investors should start to redeploy their cash. Even sitting in cash today is an active decision and both stock and bond markets will be the beneficiary of all this flow going forward.

00;02;06;22 - 00;02;34;03
Aaron Task
Okay. I just want to point out, we are speaking on April 18th. A lot may happen between now and the time this gets out to the audience. You mentioned, and I like the way you put it, that staying in cash is an active decision. What's... to play devil's advocate?

What's the compelling reason for me or any other investor or clients of our advisors here to get back into bonds when money market yields are at or near 5%?

00;02;34;06 - 00;02;52;10
Karen Veraa
I think those money market yields at 5% today are very attractive, but odds are that's really not where people need to be long term. They don't need to be sitting on cash because historically when the Fed does begin to move, we have seen that longer-term rates kind of price that in going forward. So they come down ahead of that.

And then when we have seen the Fed start to pivot and cut rates, money market yields have dropped pretty quickly. Banks stop offering, you know, great rates on CDs. And we we do tend to see that overnight rate declining pretty quickly. So where we see a lot of opportunity is really rethinking that role of fixed income in your portfolio.

If you're really looking for fixed income to provide that level of equity market diversification, cash is for stability. So it's really not going to move. But we have ETFs like AGG, which is currently the world's largest bond ETF , as an easy way to add intermediate duration and really help getting that 60/40 stock bond portfolio back in line.

We also see some tactical opportunities at 3–to-7 year part of the yield curve.

We call this the belly of the curve. It tends to reprice down pretty quickly ahead of the Fed move. And so we're seeing some interest in some of our government funds like IEI, as well as some corporate bond ETFs like IGSB as a way to get exposure to that part of the yield curve.

00;03;49;27 - 00;04;18;23
Aaron Task
That's intriguing and you mentioned something about the role of fixed income in portfolio. You referenced the 60/40 portfolio. One of the stats that jumped out at me from the No Time to Yield report is that according to our analysis, that investors are still significantly underweight fixed income with a 19% average allocation. So, I know this is a very big question, but is the 60/40 dead?

00;04;18;25 - 00;04;45;13
Karen Veraa
No, I think investors are just being more tactical than they used to be. And moving to cash or even ultra short-term fixed income served them very well during that tightening cycle. But next, I would expect people to start doing some spring cleaning of their portfolios and really think about getting that asset allocation back on track. And we talked about the role of fixed income — equity market diversification being the first and foremost. But we're also seeing people looking to selectively add more income to portfolios.

So as those cash yields begin to drop, people are thinking about ‘how can I preserve that going forward?’ And we have a series of ETFs there called iBonds. They're term maturity ETFs.

So instead of just locking up your yields today, like getting that 5% tonight in your money market fund, you could potentially lock in similar levels of yields for 2025, 2026 and beyond.

And so we're seeing a lot of investors as they’re redeploying that cash, getting that 60/40 back on track, trying to add some more stability to portfolios with products like the iBonds as a way to add more yield year after year.

00;05;22;16 - 00;05;49;05
Aaron Task
So Karen, what what is your advice to advisors who may agree with you intellectually and they've had this conversation with clients, but their clients are saying, ‘hey, you know, the bond market has not been great the last couple of years. And again, I can get five plus percent around there in cash.’

And as we talked at the top of this, you know, the Fed is not going to cut rates or doesn't appear to be ready to cut rates anytime soon.

So why do it now? Like, why not wait until the Fed starts cutting?

00;05;53;24 - 00;06;13;20
Karen Veraa
I think markets are really, really intuitive about pricing in expectations. So I think by the time you make that move, it might already be too late, meaning longer term bond yields may have already come down. and that's really what we see historically. But I do think for a lot of people, the catalyst to move won't be until the Fed cuts rates.

So there is kind of a wait and see attitude going on out there. But we think that now is a great time to really rethink this. Get back to your long-term plans, rather than just hunkering down and taking on a defensive position.

00;06;26;16 - 00;06;48;26
Aaron Task
And finally, Karen, before we wrap: 2023 was not a great year for fixed income until the very end of the year. And yet we saw bond ETF inflows hit a record $333 billion. What is this telling you about how investors are using ETFs and the role that they can play in portfolios right now?

00;06;48;29 - 00;06;55;13
Karen Veraa
The whole investor community has had a recognition of the benefits of bond ETFs as a way to add exposure for fixed income portfolios. They’re low cost, tax efficient, liquid. We've really seen the depth and breadth of exposures of bond ETFs allowing investors to have an easy way to express views and even make changes. And we've really seen a rise in model portfolios. Professional Chief Investment Officers putting together multi-asset solutions and looking for ETFs to do so.

00;07;16;15 - 00;07;23;27
Aaron Task
And you mentioned earlier that investors are maybe being more tactical. These these days: Do ETFs play a role in that?

00;07;24;04 - 00;07;35;06
Karen Veraa
I think so. I think we're seeing more investors using bond ETFs to be more tactical to express views on interest rate risk, credit risk, to get into sectors that maybe historically have been difficult to access.

00;07;35;08 - 00;07;48;13
Aaron Task
All right. Our guest has been Karen Veera, head of iShares U.S. fixed income strategy at BlackRock and one of the coauthors of our new report, No Time to Yield, which you can find, of course, on Advisor Center. Karen, thanks very much for being with us.

00;07;48;17 - 00;07;50;04
Karen Veraa
Thank you so much.

00;07;50;06 - 00;08;02;06
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