Headed into the presidential election, we saw bond ETF investors flock to riskier, higher income sectors of the market such as high yield and emerging markets. But investor sentiment and flows quickly shifted after the election. We are seeing investors position their portfolios for the possibility of higher taxes, as well as the potential for a fiscal drag stemming from either a delay in a resolution to the fiscal cliff, or from the cliff remedies themselves.
Take a look at the flows we saw in the following iShares funds from November 7 – November 13.
This is in many ways a classic flight to quality move. Faced with financial decline or uncertainty, investors invariably pull back from riskier asset classes and move into safer segments of the market—those investments that historically have been shown to hold their value—until the storm passes. This recent movement we’ve seen out of high yield has been mirrored in other risky markets such as US equities, which also saw outflows and declining values. (To learn more about the connection between high yield and equities, check out this blog.)
The current shift in market sentiment is understandable, especially for investors who are worried that the fiscal cliff and its impact could tip the United States back into a recession next year. Some may view this as an unlikely event, but it remains the course that we are on unless new legislation is passed. I believe yields on Treasuries are likely to stay low and investors are likely to approach risk assets guardedly until there are signs of a compromise on the cliff.
We would caution that investors remember to take a holistic, longer-term view of their portfolios. We would advocate favoring diversification; being overly exposed to riskier segments of the market has the potential to open a portfolio up to volatility over the next few months. While Treasuries remain a safe haven, we are not bullish on them long term due to the low level of yields. Instead, think of them as a balancer of risk in a portfolio, an investment that may not offer significant upside but that can help to provide shelter against adverse market movements.
While the relative “safety” of different investments is discussed, ETFs are not guaranteed investments. Investments in ETFs are subject to market risk. Bonds and bond funds will decrease in value as interest rates rise and are subject to credit risk, which refers to the possibility that the debt issuers may not be able to make principal and interest payments or may have their debt downgraded by ratings agencies. An investment in the Funds is not insured or guaranteed by the Federal Deposit Insurance Corporation or any other government agency. A portion of a municipal bond fund’s income may be subject to federal or state income taxes or the alternative minimum tax. Capital gains, if any, are subject to capital gains tax. Federal or state changes in income or alternative minimum tax rates or in the tax treatment of municipal bonds may make them less attractive as investments and cause them to lose value