U.S. Economic Fundamentals Remain Solid, but Uncertainty Looms Large
The U.S. economy is currently facing a high degree of uncertainty regarding macroeconomic policy outcomes, which could potentially start to impact business and consumer confidence, according to Chit Purani, the fixed-income portfolio manager for the $2.3 billion Capital Group Core Bond (CGCB) exchange-traded fund. Despite the April equity market selloff, spreads between equities and fixed-income credit have fully recovered their post-tariff rollout weakness, leaving little room for error for risk assets as market volatility is likely to persist.
With yields above 5%, fixed income has become an attractive option, Purani noted. CGCB’s mission is to deliver a consistent pattern of excess returns versus a passive index by utilizing a diverse set of levers while adhering to a high-quality mandate that prohibits the purchase of below-investment-grade bonds. This year, CGCB has seen $659 million in flows and boasts a yield of 5.1%.
The team expects greater dispersion across the credit-quality spectrum and in different parts of the yield curve in various regions due to the higher macroeconomic uncertainty. "I wouldn’t say it makes me nervous, but it’s more about focusing on where we believe we’re getting paid for the risks in multiple scenarios, whereas broadly speaking, market beta seems to be priced fairly optimistically," Purani said.
CGCB’s Approach to Credit Risk
The fund’s 37% weight in investment-grade corporate bonds may suggest that it is taking on more credit risk than its peers, but Purani emphasized that the details matter. CGCB has a higher-quality bias across sectors, which allows them to reduce the sensitivity of the portfolio to potential credit spread volatility without sacrificing much spread income.
"We’re actually taking a more defensive stance in the corporate bond space by virtue of having shorter maturity and higher quality corporate bonds in the portfolio," Purani explained. This approach is evident in their emphasis on agency mortgage-backed securities and high-quality securitized products, while de-emphasizing longer-maturity corporate sectors and issuers with a higher degree of cyclicality.
Portfolio Construction Strategies
Examples of how they are structuring the portfolio include emphasizing agency mortgage-backed securities and high-quality securitized products. "Irrespective of the market value overweight that you may be seeing, the effective risk is more defensive when you look at the corporate carve-out of our portfolio relative to a typical index," Purani said.
Among those higher-quality corporate sectors are more defensive industries such as pharmaceuticals and utilities, all with an eye to bottom-up security selection. The team has a small weight in European names and is finding value in the European banking sector, particularly banks that have very strong levels of capital and profitability with low levels of net charge-offs.
"These are providing yields and spreads that are compelling on a risk-adjusted basis versus other sectors," Purani noted.
Conclusion
The U.S. economy’s solid economic fundamentals are overshadowed by high uncertainty surrounding macroeconomic policy outcomes, which could start to impact business and consumer confidence. CGCB is well-positioned with its high-quality bias across sectors, allowing them to reduce the sensitivity of the portfolio to potential credit spread volatility without sacrificing much spread income. The team’s focus on defensive industries such as pharmaceuticals and utilities, combined with their emphasis on agency mortgage-backed securities and high-quality securitized products, demonstrates a prudent approach to managing risk in uncertain market conditions.