Treasury rates aren’t the only reason domestic fixed income yields move up or down. Learn how to take advantage of unique sector factors with a multisector bond strategy.
What drives returns in the municipal and corporate bond markets?
The bottom line
Municipal and corporate yields can respond quite differently to market stress. A laddered bond investor can benefit from stressful moments in both sectors by building a multisector allocation. For optimal results, managers require teams with expertise in both asset classes who can collaborate well in the development of a rules-based investment process and trading capabilities. A properly implemented rules-based multisector process that considers tax rates, interest rates, and sharp-eyed credit selection is likely to deliver superior returns.
Corporate debt securities are subject to the risk of the issuer’s inability to meet principal and interest payments on the obligation and may also be subject to price volatility due to such factors as interest rate sensitivity, market perception of the creditworthiness of the issuer, and general market liquidity. When interest rates rise, the value of corporate debt securities can be expected to decline. Debt securities with longer maturities tend to be more sensitive to interest rate movements than those with shorter maturities. Company defaults can impact the level of returns generated by corporate debt securities. An unexpected default can reduce income and the capital value of a corporate debt security. Furthermore, market expectations regarding economic conditions and the likely number of corporate defaults may impact the value of corporate debt securities.
An imbalance in supply and demand in the municipal market may result in valuation uncertainties and greater volatility, less liquidity, widening credit spreads, and a lack of price transparency in the market. There generally is limited public information about municipal issuers. As interest rates rise, the value of certain income investments is likely to decline. Longer-term bonds typically are more sensitive to interest rate changes than shorter-term bonds. Investments in income securities may be affected by changes in the creditworthiness of the issuer and are subject to the risk of nonpayment of principal and interest. The value of income securities also may decline because of real or perceived concerns about the issuer’s ability to make principal and interest payments.