Rising rates scenario
As we look at current US interest rates, there is only a modest difference between short and long-term rate levels. Some investors are wondering if it is worth the interest rate risk (or duration risk1) to own longer duration debt for the limited added yield. As an example, as of August 27, 2018, the 10-year Treasury Bond is yielding 2.85%, while the 2-year Treasury Bill was yielding 2.65%. With only a 20 bp improvement in yield, is it worth the added duration risk of 6.5 years? We know that if interest rates rise by 1.00%, the price impact to a bond product would be that it would fall by 1x its duration. Therefore, the short-term bond fund would fall by 2% for interest rate reasons alone (assuming a 2-year duration), while the 10-year bond fund would fall by a staggering 8.5%. Is a 8.5% principal loss something that bond investors can tolerate?
If the yield curve becomes perfectly flat over the next twelve months, short term bond investors with duration profiles of 2 years should expect a total return of +2.25%, while longer duration bond investors should expect a total return of +2.85%. In this case, the 2-year yield would be 2.85% and the 10-year yield would be 2.85%.
Professional investors have long struggled to predict the path of interest rates. To that point, what if the prior example doesn't come to fruition? What other scenarios could play out? Consider two more outcomes. The first is that the yield curve flattens and shifts higher by 50 bps. If the yield curve flattens at 3.35% (the 2-year yield and 10-year yield equate at 3.35%), short term bond investors would expect a twelve month total return of +1.1%, while longer duration bond investors would receive a total return of -1.4%.
What if the front end of the yield curve3 rises less in yield than longer dated interest rates? For example, the 2-year interest rate rises by 50 bps and the 10-year interest rate rises by 75 bps4? In this scenario, short term bond investors could receive a return of +1.65% while longer dated fixed income investors would receive a return of -3.55% over a twelve month holding period. As these examples demonstrate, there are many possible outcomes for bond investors – but short term bond funds could fare better than longer dated fixed income products in some scenarios.
Natixis Loomis Short Duration Income ETF5 (LSST)
Investors looking to navigate the current interest rate environment may want to consider a short-term fixed income ETF. The Natixis Loomis Sayles Short Duration Income ETF (LSST) is US short duration bond ETF which is actively managed to take advantage of market opportunities. It is managed by the Loomis Sayles Relative Return investment team, which has nearly a century of combined bond portfolio management experience. The team has been running an institutional version of LSST for over 10-years.
2 Duration risk measures a bond's price sensitivity to interest rate changes. Bond funds and individual bonds with a longer duration (a measure of the expected life of a security) tend to be more sensitive to changes in interest rates, usually making them more volatile than securities with shorter durations.
3 The term yield curve refers to a curve on a graph in which the yield of fixed-interest securities is plotted against the length of time they have to run to maturity.
4 Basis Points (or BPS) refers to one hundredth of one percent and is used often to express differences in interest rates.
5 An exchange-traded fund, or ETF, is a marketable security that tracks an index, commodity, bonds, or a basket of assets like an index fund. ETFs trade like common stock on a stock exchange and experience price fluctuations throughout the day as they are bought and sold.
RISKS: Exchange-traded funds (ETFs) trade like stocks, are subject to investment risk, and will fluctuate in market value. Unlike mutual funds, ETF shares are not individually redeemable directly with the Fund, and are bought and sold on the secondary market at market price, which may be higher or lower than the ETF's net asset value (NAV). Transactions in shares of ETFs will result in brokerage commissions, which will reduce returns. Active ETFs, unlike typical exchange-traded funds, do not attempt to track or replicate an index. Thus, the ability of the Fund to achieve its objectives will depend on the effectiveness of the portfolio manager. There is no assurance that the investment process will consistently lead to successful investing. Equity securities are volatile and can decline significantly in response to broad market and economic conditions. Foreign securities may involve heightened risk due to currency fluctuations. Additionally, they may be subject to greater political, economic, environmental, credit, and information risks. Fixed income securities/Bonds may carry one or more of the following risks: credit, interest rate (as interest rates rise bond prices usually fall), inflation and liquidity.
The Fund seeks current income consistent with preservation of capital to pursue higher yield potential in short duration yield securities. There is no guarantee that objectives will be met.
Before investing, consider the fund's investment objectives, risks, charges, and expenses. Visit im.natixis.com for a prospectus or a summary prospectus containing this and other information. Read it carefully.
ALPS Distributors, Inc. is the distributor for the Natixis Loomis Sayles Short Duration Income ETF. Natixis Distribution, L.P. is a marketing agent. ALPS Distributors, Inc. is not affiliated with Natixis Distribution, L.P.
This material is provided for informational purposes only and should not be construed as investment advice. The views and opinions expressed above may change based on market and other conditions. There can be no assurance that developments will transpire as forecasted.