As economic uncertainty continues to plague investors' confidence in the new year, many have remained understandably leery of the fixed income market as low interest rates continue to deter investors from this asset class. Todd Rosenbluth of S&P Capital IQrecently took the time to discuss which trends investors are likely to see developing in 2013 and how fixed income ETFs may present some attractive opportunities in the near future . ETF Database (ETFdb):Broadly speaking, what are two major macroeconomic themes that you see developing in 2013?
Todd Rosenbluth (TR): There are a couple of things to highlight, first we expect there to be stronger corporate earnings growth in 2013. Capital IQ's estimate is about 10% earnings growth in this year, which will start showing up in the second quarter and accelerating through the rest of the year. This will be a driver for equity products, as well as fixed income products. We also expect the Federal Reserve to keep interest rates low, with Treasuries remaining at the low end of historical averages, near or around 2%.
ETFdb:In regards to fixed income, what are some catalysts that will promote further growth in this asset class?
TR: From a unique net perspective, we think that we will see a continuation of the trend that we saw in 2011 and 2012, that money continues to move into fixed income ETFs, and there are a couple of things that we think will help drive that. One is that the environment that we are in, which encourages investors to look for low cost ways to get yield, is perfect for low cost fixed income ETFs. We also expect to see a continued release of new products featuring fixed income. There were a number of interesting ETFs released in 2012 from issuers like iShares and State Street that had unique takes on the fixed income market that have never been attempted before, and we see this trend continuing in 2013 .
ETFdb:Given the Fed's recent hint at pulling the plug on bond repurchases at some point in 2013, how do you see this policy change potentially affecting the bond market as a whole?
TR:Every time that the Federal Reserve comes out with news, it impacts the fixed income world,and from an ETF and a long-term investor perspective, we can't over analyze and predict the outcome of each announcement. If the Federal Reserve continues to want to keep interest rates low, and we think they do, then there continues to be a reason for investors to move up the credit quality curve and move into investment grade and high yield bonds. Investors should have exposure to fixed income and ETFs offer a low cost way to do so. We aren't suggesting that investors move to a very tactile approach, we want to make sure they still have broad diversification. Investment grade bond ETFs are going to have appeal regardless of the Fed policy actions .
ETFdb:If "loose money" policies do in fact wind down this year, which segments of the bond market do you see as potential victims? How about potential beneficiaries?
TR:What we have seen is that when interest rates remain low then there isn't duration risk, which means that you can invest in longer term products and not see much of an impact. But if the Federal Reserve was to start to raise interest rates, that would be a negative for the long term bond products. We continue to like ETFs featuring investment grade bonds, given our views on the health of corporations and the earnings stability growth prospects, they will continue to have strong financial profiles. Investors can get 3 to 4% yield through these funds without taking on much credit quality risks.
ETFdb: Do you think that improving confidence in the global recovery is outright bad news for fixed income?
TR:Again, it comes down to where within the asset class that you are focusing on. If we see improvements in the global economy in 2013 that is a positive for investment grade corporate bonds or high yield corporate bonds, but will not be seen as such for Treasury funds. If the global economy stabilizes investors will be more likely to take on risk and move out of safe haven funds.
Bottom Line:Though equity markets have gotten off to a relatively good start this year, investors should still keep a close eye on fixed income products, as this corner of the market still presents some appealing opportunities for investors. And according to S&P Capital IQ, exchange-traded products are perhaps the most cost-effective and efficient means of establishing exposure to this coveted asset class.
Disclosure: No positions at time of writing.