A Sharp Portfolio for a Challenging Bond Backdrop

On Wednesday, the Federal Open Market Committee ( FOMC ) signaled interest rates will remain low for the foreseeable future. That means advisors and clients will continue facing challenges when it comes to generating income, but the WisdomTree Fixed Income Model Portfolio can help ease the income burden. “This model portfolio is focused on a diversified stream of income.

Source: A Sharp Portfolio for a Challenging Bond Backdrop

It seeks to benefit from secular trends we see evolving in the fixed income markets in a risk-conscious manner. The model portfolio focuses on select opportunities in core sectors, while strategically allocating among sectors and extending the model portfolio’s reach globally,” according to WisdomTree.

The WisdomTree Fixed Income Model Portfolio features eight ETFs with varying credit qualities and durations. With budget deficits beyond bloated, the model portfolio is worth considering today.

“Against this backdrop, it appears the more likely Fed policy headlines for this year will center around its balance sheet. But before any possible taper talk, the UST market has been waiting to see if the policy makers will make any shifts in the composition of their purchases,” said Kevin Flanagan, WisdomTree head of fixed income, in a Wednesday note.

Seasoned fixed income investors know that the lower they go in terms of credit quality, the higher the risk profile they take on.

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“In terms of the Fed’s balance sheet, the policy makers’ holdings of Treasuries, mortgage-backed securities (MBS) and agencies have now topped $7 trillion. The accompanying graph reveals a bit of a sawtooth pattern since spring of last year, but the unmistakable trend is one of higher totals. In fact, since March 2020, the Fed’s System Open Market Account (SOMA) has risen by over $3.1 trillion, with a little under $300 billion occurring year-to-date,” notes Flanagan.

MBS are created when an entity acquires a bundle of mortgages and then sells the securities. Most MBS are seen as ‘pass-through’ security where the principal and interest payments are passed through the issuer to the investor.

While MBS may offer modestly higher yields relative to U.S. Treasuries, the mortgage-backed bonds are exposed to prepayment risk – if rates dip before the security’s maturity, a homeowner can refinance debt, causing an investor to get back the principal early and reinvest it in a security with a lower yield.

“What often gets overlooked by investors is that even though the Fed is buying Treasuries at a rather aggressive clip, rates can still rise, specifically in the intermediate to longer duration areas. This possible development is important to keep in mind when positioning your fixed income portfolio,” concludes Flanagan.

For more news, information, and strategy, visit the Model Portfolio Channel.

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