MARKETVIEW
Ultra-ShortBonds:HoldingTheirOwninaStressfulEnvironment
February13,2017
1815Views
Forinvestorslookingforlowduration,relativepricestability,andtheabilityto
benefitfromrisingshort-termrates,corporatefloating-ratenotesmayofferall
ofthesefeaturesinaninvestment-gradeassetclass.
InBrief
U.S.ultra-shortbondshavebeenrelativelystableduringthisrecentperiodof bondmarket
volatility.
U.S.investment-gradecorporatef loating-ratenotes(FRNs)—onecomponentof ultra-short
strategies—canprovideasourceof attractiveincome,withlowinterest-ratesensitivity.
FRNsmayprovideaninvestment-gradealternativetobankloansf orthoselookingtobenef it
f romarisingLondoninterbankof f eredrate(LIBOR).
AVolatilePeriod
Lastf all,weexaminedtheopportunitiesinultra-shortbondstrategies,whichgenerallyare
def inedashigh-qualityf ixed-incomeportf olioswithanaveragedurationof lessthanoneyear.
Suchstrategieshaveseenincreasedinvestordemandoverthepastyear,especiallyinlightof
money-marketref ormsthattookplaceinOctober2016.
Whathashappenedsincethen?Shortlyaf tertheadoptionof money-marketref orm,withthe
electionof PresidentDonaldTrump,thebondmarketsuf f eredasignif icantsell-of f .Accordingto
Bloomberg,theyieldonthe10-yearU.S.Treasurybondjumped,to2.60%,bymid-December,a
moveof morethan100basispoints(bps)f romitslevelinlateSeptember,and125bpsof f thelow
pointinyieldsreachedinearlyJuly.Short-maturityyieldsclimbedaswell,withtheyieldonthetwoyearTreasurybondincreasingby60bpsinthesecondhalf of 2016,accordingtoBloomberg.This
ledtolossesinmanysegmentsof f ixedincome(asoutlinedinthebottomrowof Table1),with10yearTreasuries(asmeasuredbytheCitigroup10-YearTreasuryBondIndex)decliningby7.5%
andtheBloombergBarclaysU.S.AggregateBondIndexsuf f eringa2.5%loss.EvenshortmaturityTreasuries(asrepresentedbytheBloombergBarclays1-3YearTreasuryIndex)posted
amodestlossof 0.6%overthissix-monthperiod.
Table1:Ultra-ShortStrategiesGeneratedPositiveReturnsDuringtheRecentRisein
InterestRates
PerformanceduringperiodswhenU.S.Treasuryyieldsincreased100bpsormore
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Source:Morningstar.Ten-yearTreasuryrepresentedbytheCitigroup10-YearTreasuryBondIndex.Past
performanceisnoguaranteeoffutureresults.Forillustrativepurposesonlyanddoesnotrepresentanyspecif ic
portf oliomanagedbyLordAbbettoranyparticularinvestment.Indexesareunmanaged,donotref lectthededuction
of f eesorexpenses,andarenotavailablef ordirectinvestment.
Duringthisperiodofrisingrates,credit-sensitivesectorsof themarket(includinghigh-yield
bonds,f loating-rateloans,andshort-terminvestment-gradecorporatebonds)allgenerated
positivereturns.Butamonginvestment-gradeassets,lower-durationbondsexhibitedthemost
stability.Abroadmeasureof ultra-shortbondstrategies(asrepresentedbytheMorningstarUltra
ShortBondCategoryAverage)generatedpositivereturnsduringthisvolatilemovetohigher
interestrates.
Investment-GradeFloating-RateNotes
Withintheultra-shortbonduniverse,oneassetclassthatperf ormedrelativelywellduringperiods
of risingU.S.Treasuryyieldswasinvestment-gradecorporatef loating-ratenotes(FRNs).These
arebondsissuedbyinvestment-gradecompanieswithf loating-ratecoupons,typicallybasedona
spreadoverashort-termbenchmarkrate,suchasthree-monthLIBOR.Unlikeatraditionalf ixedratebond,wherethecouponisconstantoverthelif eof thebond,thecouponsonFRNswillreset,
generallyeverythree-monthperiod,andadjustupanddownwithmovesinLIBOR.Asaresultof
thisstructure,f loating-ratenoteshavelowerdurationandlessinterest-ratesensitivitythanlongerdurationf ixed-ratebonds.Thisalsoleadstolowervolatilitythanlonger-durationassets,and
greaterpricestabilityduringperiodsof risingrates.ThisisillustratedinTable1,whichshowsthat
FRNshavegeneratedpositivereturnsineachof thepastf iveperiodsof risingrates(periods
whenthe10-yearTreasuryyieldrosebymorethan100bps).
Inadditiontogreaterpricestability,f loating-ratenotesalsocanbenef itf romrisingrates,astheir
incomestreamwillincreasewithmovesinshort-termrates.Chart1illustrateshowthishas
transpiredoverthepast16months.Therehavebeenmanyarticlesf ocusingonthemovesin
three-monthLIBOR,recentlybreaching1.0%,versus0.3%inlate2015.AsLIBORhasmoved
higher,theaveragecouponintheBloombergBarclaysCorporateFloatingRateNoteIndexhas
movedhigheraswell.
Whataboutgoingf orward?Futuremovementsininterestratesarenotoriouslydif f iculttopredict
withanyaccuracy,butthemarketconsensusexpectstwotothreeratehikesof 0.25%eachby
theFOMC(FederalOpenMarketCommittee,theFed’spolicymakingarm)overthenextyearorso.
Therateonthree-monthLIBORgenerallyhasmovedwiththef edf undstargetrate,soonewould
expectasimilarmoveinthecouponrateof f loating-ratenotes.
Chart1:FloatingRateNotes–CouponsHaveAdjustedHigherwithLIBOR
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DataasofJanuary31,2017
Sources:Bloomberg.AveragecouponasmeasuredbytheBloombergBarclaysU.S.FloatingRateNoteIndex.Past
performanceisnoguaranteeoffutureresults.Forillustrativepurposesonlyanddoesnotrepresentanyspecif ic
portf oliomanagedbyLordAbbettoranyparticularinvestment.Indexesareunmanaged,donotref lectthededuction
of f eesorexpenses,andarenotavailablef ordirectinvestment.
Theseattributesmakeinvestment-gradef loating-ratenotesanattractivecomponentof anultrashortbondstrategy.Theadditionalcreditspreadcanprovideattractivetotal-returnopportunityin
excessof short-termTreasurysecurities,whilethef loating-ratecouponleadstomuchlower
interest-ratesensitivityandmuchlessvolatilitywhencomparedtolonger-durationassets.Inf act,
overthepastthreeyears,theFRNIndexhashadlessthanhalf thevolatilityof theBloomberg
Barclays1-3YearTreasuryIndexandonlyabout12%of thevolatilityof theBloombergBarclays
U.S.AggregateBondIndex.
Chart2:Floating-RateNotesHistoricallyHaveExhibitedLowVolatility
Trailingthreeyears,asofDecember31,2016
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Source:Bloomberg.Volatilityasmeasuredbystandarddeviation.Pastperformanceisnoguaranteeoffuture
results.Forillustrativepurposesonlyanddoesnotrepresentanyspecif icportf oliomanagedbyLordAbbettorany
particularinvestment.Indexesareunmanaged,donotref lectthedeductionof f eesorexpenses,andarenotavailable
f ordirectinvestment.
Table2:Floating-RateNotesHaveLow-InterestRateSensitivity
IndexdataasofJanuary31,2017
Source:Bloomberg.Pastperformanceisnoguaranteeoffutureresults.Forillustrativepurposesonlyanddoesnot
representanyspecif icportf oliomanagedbyLordAbbettoranyparticularinvestment.Indexesareunmanaged,donot
ref lectthedeductionof f eesorexpenses,andarenotavailablef ordirectinvestment.
Itshouldbenoted,however,thatthef loating-ratecouponinitself doesnotremoveallsourcesof
volatility—onemusttakeintoaccountthef inalmaturityof thebondaswell.If youhaveaperiodof
signif icantcreditdeteriorationandcredit-spreadwidening,thatcantranslatetopricevolatilityon
longer-maturityf loatingnotes.Inotherwords,thef loating-ratecouponreducestheinterest-rate
duration,butnotthecredit-spreadduration.Inordertoensuregreaterpricestability,onecan
f ocusonshort-maturityf loating-ratenotes.Forexample,theportionof theBloombergBarclays
U.S.FloatingRateNote[FRN]Indexthatincludesonlybondswithf inalmaturitiesof lessthan18
monthshashad,historically,signif icantlylowervolatilitythanthebroadBloombergBarclaysFRN
Index.
APointofClarification
Theinvestment-gradecorporatef loating-ratenotesdescribedaboveshouldnotbeconf usedwith
f loating-ratebankloansthatarecommonlyf oundinf loating-ratemutualf unds.Alsoknownas
leveragedloansorseniorbankloans,theseareloansthataremadetobelowinvestment-grade
companies.Seniorbankloansalsohavef loating-ratecoupons,typicallytiedtothree-month
LIBOR.Asabelowinvestment-gradeassetclass,however,seniorloansof f erhigherincomeand
highertotal-returnpotential,buttheydocomewithahigherdegreeof creditriskandvolatility.
Wealsoseeattractiveopportunitiesinbankloanstoday.Bankloansof f erattractiveincome,with
littleinterest-rateexposure,andhavethebenef itof f loating-ratecouponstobenef itf roma
potentialrising-rateenvironment.Theyalsoprovidevaluableportf olio-diversif icationbenef its,
giventheirnegativecorrelationwithinvestment-gradebonds.Whiletheyaresubjecttocreditrisk,
weremainpositiveontheoutlookf orcreditconditions,andbelievethattheworstof thedef ault
cyclehaspassed,especiallyincontextof animprovingU.S.economy.
However,bankloansmightnotbeappropriateaspartof anultra-shortbondstrategy.For
investorslookingf orthebenef itof thef loating-ratef eature—namely,lowduration,relativeprice
stability,andtheabilitytobenef itf romrisingshort-termrates—corporatef loating-ratenotes
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providethesef eaturesinaninvestment-gradeassetclass.
SummingUp
Investorshavetakenacloserlookatultra-shortbondstrategiesastheyconsidertheiroptionsf or
allocatingexcesscash.Giventheirresilienceduringthisrecentperiodof bondmarketvolatility,
ultra-shortstrategieshaveheldupasanoptiontopotentiallygeneratehigherreturnsthancashor
moneymarketf unds,withlowervolatilitythanshort-orintermediate-termbonds.
Thiscommentarymaycontainassumptionsthatare“f orward-lookingstatements,”whicharebasedoncertain
assumptionsof f utureevents.Actualeventsaredif f iculttopredictandmaydif f erf romthoseassumed.Therecanbe
noassurancethatf orward-lookingstatementswillmaterializeorthatactualreturnsorresultswillnotbematerially
dif f erentf romthosedescribedhere.
ANoteaboutRisk:Thevalueof investmentsinf ixed-incomesecuritieswillchangeasinterestratesf luctuateandin
responsetomarketmovements.Generally,wheninterestratesrise,thepricesof debtsecuritiesf all,andwhen
interestratesf all,pricesgenerallyrise.Bondsmayalsobesubjecttoothertypesof risk,suchascall,credit,liquidity,
interest-rate,andgeneralmarketrisks.High-yieldsecurities,sometimescalledjunkbonds,carryincreasedrisksof
pricevolatility,illiquidity,andthepossibilityof def aultinthetimelypaymentof interestandprincipal.Moreover,the
specif iccollateralusedtosecurealoanmaydeclineinvalueorbecomeilliquid,whichwouldadverselyaf f ectthe
loan’svalue.Longer-termdebtsecuritiesareusuallymoresensitivetointerest-ratechanges;thelongerthematurity
of asecurity,thegreatertheef f ectachangeininterestratesislikelytohaveonitsprice.Lower-ratedbondsmaybe
subjecttogreaterriskthanhigher-ratedbonds.Noinvestingstrategycanovercomeallmarketvolatilityorguarantee
f utureresults.Statementsconcerningf inancialmarkettrendsarebasedoncurrentmarketconditions,whichwill
f luctuate.Aninvestmentinamoneymarketf undisnotabankdepositandisnotinsuredorguaranteedbytheFederal
DepositInsuranceCorporationoranyothergovernmentagency.Althoughretailmoneymarketandgovernmentmoney
marketf undsseektopreservethevalueof yourinvestmentat$1.00pershare,thesef undscannotguaranteetheywill
doso;itispossibletolosemoneybyinvestinginamoneymarketf und.Forinvestorswhorequireaccesstotheircash
intimesof stress,aliquidityfeemaybeleviedinordertopayf orthatliquidity(thatis,investorsmightberequiredto
payaf eeif theyredeemsharesduringthistime).Thismaybeappliedatthediscretionof theboardof directorsinthe
bestinterestof shareholdersof thef und.Aredemptiongateisatemporarymeasurethatmaybeimplementedbya
f und’sboardof directorsthatlimitsredemptionsinaf undf orashortperiodof time(upto10businessdaysina90dayperiod).Itspurposeistopreventarunonaf undintimesof marketstress.
TreasuriesaredebtsecuritiesissuedbytheU.S.governmentandsecuredbyitsf ullf aithandcredit.Incomef rom
Treasurysecuritiesisexemptf romstateandlocaltaxes.AlthoughU.S.governmentsecuritiesareguaranteedasto
paymentsof interestandprincipal,theirmarketpricesarenotguaranteedandwillf luctuateinresponsetomarket
movements.
TheBloombergBarclaysU.S.AggregateBondIndexrepresentssecuritiesthatareSEC-registered,taxable,and
dollardenominated.TheIndexcoverstheU.S.investment-gradef ixed-ratebondmarket,withindexcomponentsf or
governmentandcorporatesecurities,mortgagepass-throughsecurities,andasset-backedsecurities.Totalreturn
comprisespriceappreciation/depreciationandincomeasapercentageof theoriginalinvestment.
TheBloombergBarclaysU.S.Treasury1-3YearIndexmeasurestheperf ormanceof governmentbondsissuedby
theU.S.Treasurywithmaturitiesrangingbetweenonetothreeyears.
TheBloombergBarclaysU.S.TreasuryBill3-6MonthIndexmeasurestheperf ormanceof governmentbillsissued
bytheU.S.Treasurywithmaturitiesrangingbetweenthreeandsixmonths.
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TheBloombergBarclaysU.S.FloatingRateNote(FRN)Indexmeasurestheperf ormanceof investment-grade
f loating-ratenotes.
TheBloombergBarclaysU.S.FloatingRateNote(FRN)‹18-MonthIndexmeasurestheperf ormanceof investmentgradef loating-ratenoteswithmaturitiesof lessthan18months.
TheCitigroup10-YearTreasuryBondIndexisabroadmeasureof theperf ormanceof medium-termU.S.Treasury
securities.
MorningstarCategoryAverages:Mutual-f undresearchf irmMorningstarclassif iesf undsintocategoriesaccordingto
theiractualholdingsratherthantheobjectivesstatedbythef undmanagementcompany.Morningstarthencalculates
categoryaveragedataf orseveralmetrics,includingperf ormance,expenses,portf olioexposures,andmore.
Abasispointisoneone-hundredthof apercentagepoint.
LIBORisaninterestrateatwhichbankscanborrowf unds,inmarketablesize,f romotherbanksintheLondon
interbankmarket.TheLIBORisf ixedonadailybasisbytheBritishBankers'Association.TheLIBORisderivedf roma
f ilteredaverageof theworld'smostcreditworthybanks'interbankdepositratesf orlargerloanswithmaturities
betweenovernightandonef ullyear.
Mutualf undsgenerallymustcalculatetheirnetassetvalue(NAV)atleastonceeverybusinessday,typicallyaf ter
themajorU.S.exchangesclose.TheNAVof asingleshareof af und(orthe"pershareNAV")iscalculatedbydividing
thef und’sNAVbythenumberof sharesthatareoutstanding.
Standarddeviationisameasureof ameasureof volatility.Itindicatesthevariabilityof aninvestment'sreturns.
Abondyieldistheamountof returnaninvestorwillrealizeonabond.Thoughseveraltypesof bondyieldscanbe
calculated,nominalyieldisthemostcommon.Thisiscalculatedbydividingtheamountof interestpaidbythef ace
value.
Acouponrateistheyieldpaidbyaf ixed-incomesecurity;af ixed-incomesecurity’scouponrateissimplytheannual
couponpaymentspaidbytheissuerrelativetothebond’sf aceorparvalue.Thecouponrateistheyieldthebondpaid
onitsissuedate.
Thecreditqualityof thesecuritiesinaportf olioisassignedbyanationallyrecognizedstatisticalratingorganization
(NRSRO)suchasStandard&Poor’s,Moody’s,orFitch,asanindicationof anissuer’screditworthiness.Ratingsrange
f rom‘AAA’(highest)to‘D’(lowest).Bondsrated‘BBB’oraboveareconsideredinvestmentgrade.Creditratings‘BB’
andbelowarelower-ratedsecurities.Highyielding,non-investment-gradebondsinvolvehigherrisksthaninvestmentgradebonds.Adverseconditionsmayaf f ecttheissuer’sabilitytopayinterestandprincipalonthesesecurities.
TheopinionsinMarketViewareasof thedateof publication,aresubjecttochangebasedonsubsequent
developments,andmaynotref lecttheviewsof thef irmasawhole.Thematerialisnotintendedtoberelieduponas
af orecast,research,orinvestmentadvice,isnotarecommendationorof f ertobuyorsellanysecuritiesortoadopt
anyinvestmentstrategy,andisnotintendedtopredictordepicttheperf ormanceof anyinvestment.Readersshould
notassumethatinvestmentsincompanies,securities,sectors,and/ormarketsdescribedwereorwillbeprof itable.
Investinginvolvesrisk,includingpossiblelossof principal.Thisdocumentispreparedbasedontheinf ormationLord
Abbettdeemsreliable;however,LordAbbettdoesnotwarranttheaccuracyandcompletenessof theinf ormation.
Investorsshouldconsultwithaf inancialadvisorpriortomakinganinvestmentdecision.
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