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DURATION
February 2024

The March Toward Added Duration

While intermediate-term fixed-income funds saw approximately $186 billion in inflows in 2023, this was dwarfed by the $959 billion of inflows into money-market funds (a 24% increase from 2022). With money-market fund assets under management (AUM) near historic levels, could fixed income see a wave of inflows into duration in 2024 in anticipation of the Federal Reserve potentially cutting rates?

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Estimated Net Flows for Various Asset Classes in 2023
The March Toward Added Duration
Source:
Morningstar as of 7/31/2023.

Categories shown in chart are Morningstar asset classes. Duration measures a bond’s or fund’s sensitivity to interest rates. The longer a fund’s duration, the more sensitive it is to interest-rate risk. The shorter a fund’s duration, the less sensitive it is to interest-rate risk. An intermediate-term bond is a type of bond or other fixed-income security that has a maturity date set for between two and 10 years. Intermediate-term core bond portfolios invest primarily in investment-grade U.S. fixed-income issues including government, corporate, and securitized debt, and hold less than 5% in below-investment-grade exposures. Intermediate-term core-plus bond portfolios invest primarily in investment-grade U.S. fixed-income issues including government, corporate, and securitized debt, but generally have greater flexibility than core offerings to hold non-core sectors such as corporate high yield, bank loan, emerging-markets debt, and non-U.S. currency exposures. Long government bonds refer to the 30-year Treasury bond. Emerging-markets bond portfolios invest more than 65% of their assets in foreign bonds from developing countries. Bank loans (or floating-rate loans) are financial instruments that pay a variable or floating interest rate. A floating-rate fund invests in bonds and debt instruments whose interest payments fluctuate with an underlying interest-rate level. Inflation-protected bond portfolios primarily invest in fixed-income securities that increase coupon and/or principal payments at the rate of inflation. Short-term bond portfolios invest primarily in corporate and other investment-grade U.S. fixed-income issues and have durations of one to 3.5 years.

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CORPORATE BONDS
,
February 2024
Can BBB Corporate Bonds Help Make Up for the Agg's Poor Performance in 2021 and 2022?
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Can BBB Yields Make Up for Agg Losses?

Despite a rally last year in fixed income, many investors may find themselves in a hole when it comes to their core fixed-income position with the total return for the Bloomberg US Aggregate Bond index over the past three years at -9.62%. When you back out yield and just look at price return, those returns fall to -16.70%. Though the index yield still sits near a multi-decade high of 4.53%, it could take over two years for investors to see positive returns on core fixed-income positions added three years go. On the other hand, BBB investment-grade corporate bonds could help shorten that breakeven period, as BBB corporates started the year with a yield of 5.28%.

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BANK LOANS
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YIELDS
,
February 2024
Yields and Volatility Over the Past Three-Plus Years
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Yield, Volatility and Bank Loans

Historically, if investors wanted higher levels of yield, they would have to take on higher levels of volatility. But over the past three-plus years, bank loans have had lower levels of volatility than most investment-grade areas of the fixed-income market with higher levels of yield. Bank loans currently offer investors more than two times the yield of the Bloomberg US Aggregate Bond Index, while having delivered 50% less volatility over the past three years.

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ECONOMY
,
February 2024
Returns From the Last Soft Landing After Fed Rate-Hiking Cycle (Feb. 1995 to Nov. 1998)
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What Happened During the Last Soft Landing?

The last time the economy had a soft landing after a Federal Reserve rate-hiking cycle occurred in 1995. In the nearly four years after the end of that rate hiking cycle when the Fed held rates relatively stable, investment-grade corporate bonds outperformed many fixed-income asset classes. The Fed’s current hiking cycle, which to date has closely paralleled the one in the mid-1990s, may have the economy coming in for a similar soft landing. If the economy continues on this path, corporate credit may be an attractive option for investors who are looking to find more yield.

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INVESTMENT GRADE
,
February 2024
Historical Yields for Investment-Grade Bonds vs. Yields at the Start of 2024
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Completing the IG Total-Return Equation

While yield levels remain elevated across fixed-income asset classes, investment-grade corporate bonds may have some price appreciation left for 2024. Historically1, when investment-grade corporate bond yields have been within 25 basis points or 50 basis points of current levels, the average price of the asset class has been 8.7% and 9.0% higher, respectively, than current levels, completing the other half of the total-return equation.

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INVESTMENT GRADE
,
January 2024
Performance of Intermediate IG Corporate Bonds vs. the Agg Since 1990
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Intermediate IG Bond Performance vs. the Agg

While some investors would think that intermediate investment-grade (IG) corporate bonds only do well when risk assets have rallied, historically the asset class has outperformed the Bloomberg US Aggregate Bond Index (Agg) in both good times and bad. Looking at rolling three-year return periods, when the Agg has returned 0% or less, intermediate investment-grade corporate bonds have outperformed the index by an average of 2.01%. And when returns for the Agg has returned 5% or more, intermediate investment-grade corporate bonds have outperformed the Agg by 0.77%.

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BANK LOANS
,
December 2023
Bank Loans in a Declining-Rate Environment (top) and a Flat-Rate Environment (bottom)
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The Resiliency of Bank Loans

The common perception of many investors is that bank loans (or floating-rate loans) only outperform in periods of rising rates. A less frequently discussed topic is how the asset class performs in periods of flat and declining rate environments.

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INVESTMENT GRADE
,
December 2023
Performance of Investment-Grade Corporate Bonds vs. Diversified Bond Index
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How IG Bonds Have Fared Compared to a Diversified Bond Index

With investment-grade corporate bonds, investors might have the opportunity to capture higher yields and potential excess return compared to a diversified bond index. Since 1981, the Bloomberg US Corporate Investment Grade Index has generated:

• A higher 3-year rolling return than the Bloomberg US Aggregate Bond Index 77.5% of the time.

• Seven periods of a 3-year rolling return greater than 19% compared to just two from the Bloomberg US Aggregate Bond Index.

• Only four periods of a 3-year rolling return less than -1% compared to six periods from the Bloomberg US Aggregate Bond Index.

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CORPORATE BONDS
,
November 2023
Risk/Return Characteristics 12 Months After the Fed Paused its Rate-Hiking Cycle in 2018
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How Did Intermediate IG Bonds Perform After the Fed's Last Pause in 2018?

In the 12 months following the Federal Reserve’s last rate hike in December 2018, intermediate investment-grade corporate bonds outperformed the Bloomberg US Aggregate Bond Index by 1.42%. In addition to the higher returns, intermediate investment-grade corporate bonds also generated during this period 28% less volatility than the Bloomberg US Aggregate Bond Index; 57% less max drawdown than the Bloomberg US Aggregate Bond Index; and higher returns in the best and worst quarter than the Bloomberg US Aggregate Bond Index.

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CORPORATE BONDS
,
November 2023
Corporate Debt vs. Treasuries and Mortgage-Backed Securities Over Past 40 Years (Growth of $10,000 Investment)
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Over the Long Run, Corporate Debt Has Outperformed Treasuries and MBS

Historically, the additional yield or spread offered by corporate debt has paid off for patient investors. Corporate debt has outperformed two of its more conservative fixed-income counterparts—U.S. Treasuries and mortgage-backed securities—over the past 31 rolling 10-year periods. Investment-grade corporate bonds outpaced those two asset classes 97% of the time, and high-yield outperformed them 90% of the time.

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INVESTING
,
November 2023
Price Return vs. Total Return
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Why Now May Be the Time for Tax-Loss Harvesting

Since most fixed-income funds distribute the majority of their return in the form of monthly distributions, their price return is usually well below the total return. For example, the Bloomberg US Aggregate Bond Index has generated a price return of -2.67% over the trailing 12 months and -11.74% over the past five years. On the other hand, the total return for the index (adding distributions and capital gains) was 0.64% for the trailing 12 months and 0.51% for the past five years. Knowing this, investors may want to take advantage of the current environment and consider tax-loss harvesting their fixed-income losses from what have historically been considered conservative investment options.

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CORPORATE BONDS
,
December 2023
Potential 12-month return if interest rates decreased by 1%
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What Might Happen if the Fed Lowers Rates?

Bond prices have an inverse relationship to yield: When yield or interest rates increase or decrease, bond prices move in the other direction. By looking at the duration of an asset class, you can potentially estimate how much bond prices might move for every 1% shift in interest rates. Then you could add in the current yield to estimate the potential 12-month return. With the Federal Reserve now on pause, and the market likely anticipating rate cuts in 2024, here is a look at what the potential return might be for specific investment-grade fixed-income asset classes based off current duration and yield levels if the Fed decreased interest rates by 1%.

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YIELDS
,
October 2023
Volatility vs. Yield
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Not All Yield Comes With Large Volatility

Historically, higher levels of yield meant higher levels of volatility. However, this has not been the case with bank loans. Over the past three years, bank loans have had lower levels of volatility with higher levels of yield compared to most investment-grade, fixed-income asset classes.

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DURATION
,
September 2023
Performance After Fed Rate-Hiking Cycles
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After a Hiking Cycle, Longer Duration Has Historically Outperformed Shorter Duration

Historically, intermediate core plus bond funds have significantly outperformed money market and ultra short bond funds in the 12 months following a Federal Reserve hiking cycle, as longer duration bond investors have benefited from higher yields and more attractive relative value. While investors have added $614.1 billion to money market funds so far in 2023, there may be a better investment opportunity with longer duration assets should the Federal Reserve decide to take a pause in the current rate hiking cycle.

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CORPORATE BONDS
,
September 2023
Corporate Debt Performed Well During the Previous Fed Hiking Cycle
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How Corporate Debt Performed Last Hiking Cycle

Corporate debt had strong returns during the previous Federal Reserve rate-hike cycle ending in 2018, continued to have strong returns through the pause, and outperformed other asset classes through the full cycle.

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DURATION
,
September 2023
The Benefits of Duration* 12 Months After a Fed Hiking Cycle
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Why Duration After a Rate-Hiking Cycle Ends

Historically, when a Federal Reserve rate-hiking cycle has ended, longer-duration spread sectors have materially outperformed more traditional fixed-income and shorter-duration spread sectors in the following 12 months.

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YIELDS
,
August 2023
Yield to Worst Has Increased Significantly Since 2021
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Yields Across Corporate Credit Have Been Rising

Yields across corporate credit are currently far higher than at the end of 2021. In this environment, the additional credit risk may be worth the additional yield for investors.

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CORPORATE BONDS
,
August 2023
Performance After a Fed Pause in Interest-Rate Hikes
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What Happened After Fed Last Paused Rate Hikes?

The Federal Reserve has predicted it will raise interest rates two more times in 2023. But current market expectations are for a rate pause for the rest of the year. Here's what happened the last time the Fed paused rates.

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ECONOMY
,
September 2023
Personal Savings Have Been Depleting
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The Spike in Personal Savings Has Disappeared

Thanks to the COVID relief programs, personal savings soared in 2020 and 2021, peaking at $6.5 trillion (about a 364% increase from historical levels). But over the past two years, those excess savings—which many have credited with helping keep the economy strong—have been spent.

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ECONOMY
,
August 2023
Consumer Spending Year-Over-Year
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Year-Over-Year Consumer Spending Trends

Consumer spending has been slightly up year-over-year (as of July 22, 2023), according to Bank of America credit-card spending data. While spending was significantly down in categories such as online electronics, furniture and gas, consumers have been paying more on dining and entertainment.

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CORPORATE BONDS
,
BANK LOANS
,
HIGH YIELD
,
June 2023
Historical 12-Month Returns At Varying Price and Yield Levels
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Is the Time Right for Corporate Debt?

Historically, when investment-grade corporate bonds, high-yield bonds and bank loans have reached the same price and yield levels as today's, they've generated a 12-month return well above each asset class’s 20-year annualized return (7.20% for high-yield bonds; 4.65% for investment-grade corporate bonds; and 4.65% for bank loans).

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YIELDS
,
April 2023
Bank Loans Have Outperformed Longer-Duration Asset Classes Since July 2022
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Longer Duration, Smaller Yield so far in 2023

Over the past 12 months, longer-duration asset classes have seen $99.4 billion in net inflows vs. $22.8 billion in outflows from shorter-duration categories.1 To date, this move to duration—sparked largely by the potential ending of rate hikes by the Fed—has seen bank-loan funds outperform long government bond, intermediate core bond and intermediate government bond funds in the second half of 2022, all of 2022 and 2023 year-to-date.

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CORPORATE BONDS
,
February 2023
Duration and Yield for Various Fixed-Income Asset Classes
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Duration, Yield and Fed Expectations

Some investors have started to add duration to their fixed-income investments, expecting a Federal Reserve pause in interest-rate hikes. But given the current curve inversion across various areas of fixed income, investors have been giving up yield for the sake of adding duration. With the Fed still reiterating a data-dependent approach, investors may be caught off guard if the Fed continues to raise rates without a pause.

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BANK LOANS
,
February 2023
Effective Yields: Average Bank Loan Fund vs. Credit Suisse Leveraged Loan Index
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Is it Time to Revisit Bank Loans?

In 2022, investors had few places to hide amid one of the worst market years on record. But one fixed-income asset class performed far better than others: Bank loans.

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CORPORATE BONDS
,
February 2023
Short-Term vs. Intermediate Core Bond Performance over Past 10 Years
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Short-Term vs. Intermediate Core Bonds

Fixed-income investors in intermediate core bond funds gave back 105% and 71% of their 5-year and 10-year return, respectively, in 2022. Investors who added exposure to short-term bond funds fared better; the average short-term bond fund finished 2022 with a return of -5.22% vs. -13.32% for the average intermediate core bond fund. This was the greatest margin of outperformance for short-term bond funds over intermediate core bond funds since the inception of the Morningstar Short Term Bond Category.

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BANK LOANS
,
February 2023
The 10 Worst Performance Years per Fixed-Income Asset Class
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How Have Bank Loans Performed in Down Years?

In 2022, investors had few places to hide amid one of the worst market years on record. But one fixed-income asset class performed far better than others: Bank loans.

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