Fixed Income
May 21, 2024|ByKaren Veraa, CFA
Key Takeaways:
- Locking in rates now may be beneficial before the Fed starts to cut interest rates.
- Holding bonds until maturity can help to potentially deliver yield, but buying individual bonds can be complex and time-consuming.
- BlackRock gives you choices to build ladders at scale – go with individual bonds in an SMA or build it yourself with iBonds ETFs – either way, your clients may enjoy steadier income until maturity.
Overweight to cash and short-term bonds
Fixed income portfolios can use a spring cleaning. With interest rates high and the yield curve inverted, a record amount of money has flowed into money market funds and bank deposits. While investing in cash is an active decision, this positioning may contribute to investors not meeting their long-term goals. Using data from BlackRock’s Advisor Center, the average advisor’s moderate portfolio is about 23% invested in cash and short-term instruments, compared to just 2% in BlackRock’s Target Allocation models.1
History shows bonds tend to outperform cash during the pause period and can benefit from price appreciation when interest rates fall, making now a great time to consider setting up portfolios for the next wave of the cycle. Advisors can use this interest rate pause as an opportunity to add longer maturity exposures back to client portfolios.
Figure 1: A Fed pause has historically been a good entry point for bonds
Source: Source: Bloomberg, as of 12/31/23. Total return historical analysis calculates average performance of the Bloomberg U.S. Aggregate Bond Index (bonds) and the Bloomberg U.S. Treasury Bills: 1-3 Months TR Index (cash) in the 6 months leading up to the last Fed rate hike, between the last rate hike and first cut, and the 6 months after the first cut. The dates used for the last rate hike of a cycle are: 2/1/95, 3/25/97, 5/16/00, 6/29/06, 12/19/18. Dates used for the first-rate cut are: 7/6/95, 9/29/98, 1/3/01, 9/18/07, 8/1/19. Index performance is for illustrative purposes only. Index performance does not reflect any management fees, transaction costs or expenses. Indexes are unmanaged and one cannot invest directly in an index. Past performance does not guarantee future results.
Hold bonds to maturity with ladders
One way to potentially add income and stability to portfolios is to buy bonds and hold them to maturity, which can be achieved through building bond ladders. Laddering involves buying bonds that mature in each calendar year over your time horizon. For example, a 5-year ladder would allocate 20% to bonds with maturities in five consecutive calendar years. As bonds mature, the ladder can be maintained by using cash proceeds to purchase more bonds in furthest rung of the ladder.
Figure 2: 5-year corporate ladder
For illustrative purposes only
However, accessing individual bonds as well as researching and monitoring thousands of CUSIPS can be challenging and time-consuming. Advisors can partner with BlackRock to build ladders at scale.
Built for you vs. built by you: SMAs and iBonds ETFs
For clients with larger accounts and more complex needs, separately managed accounts (SMAs) can be a potential solution. Bond SMAs allow an investor to have a professionally managed portfolio of individual bonds that can be personalized to their goals and needs. Customization options include time horizon, cash flow timing, tax status and credit ratings, to name a few. Dedicated portfolio managers help position client portfolios for developments in the bond market, and our credit research team analyzes every bond owned in the portfolio.2
For investors with smaller accounts or requiring less customization, iBonds ETFs can offer a scalable, low-cost bond solution. iBonds are designed to mature like a bond, diversify like a fund and trade like a stock. iBonds are now available in five bond market sectors; national municipals, U.S. Treasuries, TIPS, investment grade and high yield corporates. Advisors can use iBonds ETFs to create custom ladders out to ten years, express views on the curve or add duration to portfolios. iBonds pay monthly income and can be sold on exchange. Test drive our iBonds using our Bond Laddering Tool.
Figure 3: Compare SMAs and iBonds ETFs
*Fund expense ratio does not equal fees assessed on an SMA
Case study: Tax and cash flow customization: A high-net-worth client lives in California and has most of their assets in a taxable account. The client is tax sensitive and has a fifteen-year investment time horizon with some liquidity needs in year four. A municipal SMA ladder invested fully in California bonds can help maximize tax-exempt income while helping meet cash flow needs over a specific time horizon.
Case study: Required minimum distributions (RMDs): Clients must take a withdrawal from their retirement account when the account holder turns 72. The Internal Revenue Service (IRS) requires a minimum amount to be withdrawn each year thereafter, known as the RMD. From ages 72 to 82, assuming no portfolio growth, clients will need to withdraw almost 50% of the account value.
For example, a single retiree turning 72-years old in 2023 has $100,000 invested in an IRA. This client must withdraw RMDs according to the IRS Uniform Lifetime Tables, by dividing the account size by the distribution period for each year. iBonds ETFs can potentially be used to ladder out the first 10 years of RMDs and any remaining assets in the account can be invested in other assets. Since iBonds ETFs mature in mid-October or December, clients will have cash in their accounts to help meet these IRS-mandated withdrawals before year-end.
How do I get started?
iBonds ETFs and SMAs can help get fixed income portfolios back on track after two years of rising rates. Advisors can thoughtfully seek to add income and stability to portfolios before the next rate cycle begins.
Karen Veraa, CFA
Fixed Income Product Strategist
Karen Veraa, CFA, is a Fixed Income Product Strategist within BlackRock’s Global Fixed Income Group focusing on iShares fixed income ETFs.
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1 Source: Morningstar, BlackRock, Aladdin. “Advisor models” data is as of 12/31/23. “BLK model” data as of 3/14/24.
2 A personal portfolio manager and customization requests generally require a minimum investment of $1 million
Carefully consider the Funds' investment objectives, risk factors, and charges and expenses before investing. This and other information can be found in the Funds' prospectuses or, if available, the summary prospectuses, which may be obtained by visiting the iShares Fund and BlackRock Fund prospectus pages. Read the prospectus carefully before investing.
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This material is intended for use by a third-party financial professional in consultation with their client. BlackRock Investment Management, LLC (“BlackRock”) acts as either a discretionary investment manager or a non-discretionary model provider to sponsor firms in a variety of separately managed account or wrap fee programs. BlackRock is not acting in a fiduciary capacity with regard to any client of a financial professional. Results of any account or portfolio derived from this information may vary materially from the results shown herein. There is no guarantee that any investment strategy illustrated will be successful or achieve any particular level of results. Any tax information provided herein is for illustrative purposes only and does not constitute the provision of tax advice by BlackRock. Please consult with a tax professional for more information with regard to an investor’s specific situation.
Case study shown for illustrative purposes only. This is not meant as a guarantee of any future result or experience. This information should not be relied upon as research, investment advice or a recommendation regarding the Funds or any security in particular.
An investment in fixed income funds is not equivalent to and involves risks not associated with an investment in cash.
Fixed income risks include interest-rate and credit risk. Typically, when interest rates rise, there is a corresponding decline in the value of debt securities. Credit risk refers to the possibility that the debt issuer will not be able to make principal and interest payments. There may be less information on the financial condition of municipal issuers than for public corporations. The market for municipal bonds may be less liquid than for taxable bonds. Some investors may be subject to federal or state income taxes or the Alternative Minimum Tax (AMT). Capital gains distributions, if any, are taxable.
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