INVESTMENT INSIGHTS Building better fixed income portfolios
INVESTMENT INSIGHTS
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Interest rates are near their 60-year lows. Short-term rates and real yields (i.e., yields after inflation) on some fixed income investments are close to zero. For both institutional and individual investors, asset allocation remains a primary driver of investment returns. Even in a low rate environment, bonds provide needed income and can reduce overall portfolio volatility. Nevertheless, low rates, global uncertainty and the potential for inflation create challenges for fixed income investors: ? Producing enough income ? Hedging against possible losses if bond rates rise ? Combating the erosion of purchasing power over time Appropriately diversified fixed income investors can access total return opportunities while maintaining the income potential and diversification benefits that bonds have historically provided.
9/30/81: 15.84%
10% Nominal yield average: 6.23%
5%
Nominal 10-year Treasury yield 12/31/15: 2.27%
Real yield
0%
average: 2.46%
Real 10-year Treasury yield
12/31/15: 0.25%
-5%
'58
'63
'68
'73
'78
'83
'88
'93
'98
'03
'08
'13
Source: Federal Reserve, BLS, J.P. Morgan Asset Management. Data as of 12/31/15. For illustrative purposes only. Past performance is not indicative of future returns. Real 10-year Treasury yields are calculated as the daily Treasury yield less year-over-year core inflation for that month except for June 2015, where real yields are calculated by subtracting out May 2015 year-over-year core inflation.
Diversification does not guarantee investment returns and does not eliminate the risk of loss. Investments in fixed income securities are subject to interest rate risk. If rates increase, the value of the investment generally declines.
INVESTMENT INSIGHTS
THE IMPACT OF RISING RATES CAN VARY GREATLY
While bonds will likely be adversely impacted by rising rates, the impact won't be uniform across all bond types. Different bond market sectors, structures and maturities respond differently to changing interest rates. For example, high-yield bonds tend to be less sensitive to rates than U.S. Treasuries. The same is true for shorter-term bonds. That's why diversification can help manage risk and reduce the overall impact rising rates might have on your bond portfolio.
PRICE IMPACT OF A 1% MOVE IN INTEREST RATES
9.4%
8.8%
2.0%
5.2%
4.9%
4.3%
5.8%
5.7%
3.7%
2.8%
4.6%
0.1%
-2.0%
-4.5%
-4.7%
2 year 5 year TIPS
UST
UST
-8.5%
-0.1%
-4.3%
-5.2%
-5.6%
-5.3%
10 year Floating U.S. HY EMD ($) U.S.
MBS
UST
rate
Aggregate
-2.7% -4.8%
-10.7% 1-5 year 1-15 year Muni HY Munis Munis
KEY
+1%
-1%
Source: U.S. Treasury, Barclays Capital, FactSet, J.P. Morgan Asset Management. Fixed income sectors shown above are provided by Barclays Capital and are represented by Barclays U.S. Aggregate; TIPS: Barclays U.S. Treasury Inflation Protected Notes (TIPS); Floating Rate: Barclays FRN (BBB); High Yield: Corporate High Yield Index; EMD ($): Emerging Markets (USD); MBS: MBS Index; Municipals: Barclays U.S. 1-5 Year Blend (1-6) Municipal Bond Index, Barclays U.S. 1-15 Blend (1-17) Municipal Bond Index, Barclays Municipal High Yield Index. Data as of 12/31/15. This chart is for illustrative purposes only.
UNCORRELATED ASSETS CAN IMPROVE PORTFOLIO RETURNS AND LOWER VOLATILITY
Core bonds -- both taxable and tax-exempt -- have typically had little or no correlation to major equity markets. That is, equity and bond prices have tended not to move in the same direction at the same time. In addition, core bonds have historically been less volatile than stocks. All other things being equal, lower volatility in and of itself can improve overall portfolio returns. As a result, combining a broad mix of stocks with strategically diversified fixed income investments can improve a portfolio's balance of return opportunity and expected risk.
High-quality bonds have negative correlations to equities
CORRELATION TO THE S&P 500 1.00
0.57
0.62
0.04
-0.10
-0.09
-0.31
S&P
BC Muni 1?17
BC Agg
BC US Treasury
BC EMD
BC US HY
Commodity Index
Source: Standard & Poor's, Barclays Capital Inc., MSCI Inc., DJ UBS, J.P. Morgan Asset Management. Data as of 12/31/15.
Correlation to Core Bonds as represented by the Barclays U.S. Aggregate Index. Indexes used: U.S. Equities: S&P 500 Index; Corporate High Yield: Barclays Corporate High Yield; EMD: Barclays Capital Emerging Market Index; Municipal Bonds: Barclays Blend 1-15 Year (1-17 Y); TIPS: Barclays U.S. Treasury Inflation Protected Notes (TIPS); Treasuries: U.S. Treasuries. All correlation coefficients calculated based on monthly total return data for period 12/31/03 to 12/31/15. This chart is for illustrative purposes only.
2 ALLOCATION SOLUTIONS -- EVOLVING YOUR FIXED INCOME STRATEGY
Fixed income
DIVERSIFICATION MAY HELP REDUCE RISK AND PROVIDES ACCESS TO BROADER OPPORTUNITIES
The performance of individual fixed income sectors can be volatile. As with stocks, a portfolio concentrated in one specific bond sector can lead to a bumpy ride. Diversification helps lower portfolio volatility and can reduce the impact of credit, rate and other risks. By allowing access to broader opportunities, diversification can also increase income and improve portfolio performance. For example, a diversified portfolio outperformed taxable core bonds over the past 10 years.
Fixed income sector returns
GTM ? U.S. | 39
INVESTORS CAN BENEFIT FROM DIVERSIFICATION WITHIN FIXED INCOME
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
2005 - 2015
Cum.
Ann.
EMD USD 10.2%
EMD LCL. 15.2%
EMD LCL. 18.1%
Treas. 13.7%
High Yield EMD LCL.
58.2%
15.7%
TIPS 13.6%
EMD USD High Yield
17.4%
7.4%
Muni 8.7%
Muni 3.8%
EMD USD 114.0%
EMD USD 7.9%
EMD LCL.
6.3% Asset Alloc. 3.1%
TIPS
2.8%
High Yield
11.8%
EMD USD
9.9% Asset Alloc. 5.7%
TIPS
11.6%
Treas.
9.0% Barclays
Agg 7.0%
Treas. 2.8%
MBS 5.2%
Muni 2.7% High Yield 2.7%
Muni
4.7% Barclays
Agg 4.3%
MBS
6.9% Asset Alloc. 6.7%
EMD USD
6.2%
MBS
2.6% Barclays
Agg 2.4%
Corp. 4.3% Treas. 3.1%
Corp. 4.6% Muni 4.3%
MBS 8.3% Barclays Agg 5.2%
Muni 1.5% Asset Alloc. 0.1%
TIPS -2.4%
Corp. -4.9%
EMD LCL. -5.2%
EMD USD
-12.0%
EMD USD High Yield
29.8%
15.1%
Muni 12.3%
EMD LCL. EMD USD
22.0%
12.2%
Treas. 9.8%
Corp.
18.7% Asset Alloc. 14.7%
TIPS
11.4%
Corp.
9.0% Asset Alloc. 7.9% Barclays Agg 6.5%
Corp.
8.1% Asset Alloc. 8.1% Barclays Agg 7.8%
Muni
9.9% Barclays
Agg 5.9%
TIPS 6.3% Treas. 5.9%
EMD USD 7.3% MBS 6.2%
MBS
MBS
High Yield
5.9%
5.4%
5.0%
EMD LCL. 16.8%
High Yield 15.8%
Corp. 9.8% Asset Alloc. 7.4%
TIPS 7.0%
Muni 5.7% Barclays Agg 4.2%
MBS
2.6%
MBS -1.4%
Corp. -1.5% Asset Alloc. -1.9% Barclays Agg -2.0%
Muni -2.2%
Treas. -2.7%
EMD USD -5.3%
TIPS
-8.6%
Corp. 7.5%
EMD USD 7.4%
MBS 6.1% Barclays Agg 6.0% Asset Alloc. 5.5%
Treas. 5.1%
TIPS 3.6%
High Yield
2.5%
MBS 1.5%
EMD USD 1.2%
Treas. 0.8% Barclays Agg 0.5% Asset Alloc. -0.3%
Corp. -0.7%
TIPS -1.4%
High Yield
-4.5%
High Yield 101.3%
Muni 70.6%
Corp. 70.2% Asset Alloc. 69.4%
EMD LCL. 62.0%
MBS 61.4% Barclays Agg 59.3%
Treas.
54.8%
High Yield 7.2%
Muni 5.5%
Corp. 5.5% Asset Alloc. 5.4%
EMD LCL. 4.9%
MBS 4.9% Barclays Agg 4.8%
Treas.
4.5%
Corp.
TIPS
High Yield High Yield Treas.
Muni
EMD LCL. Treas. EMD LCL. EMD LCL. EMD LCL.
TIPS
TIPS
1.7%
0.4%
1.9%
-26.2%
-3.6%
4.0%
-1.8%
2.0%
-9.0%
-5.7%
-14.9%
51.2%
4.2%
Source: Barclays Capital, FactSet, J.P. Morgan Global Economic Research, J.P. Morgan Asset Management.
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Paarestrpeeprrfeosremnatnecdebiys nBortoainddiMcaatrivkeeto: fBfaurtculraeyrseCtuarnpsit.aFl iUxe.Sd.inAcgogmreegsaetcetoIrnsdsehxo;wMnBaSb:oFveixaerdeRparotevidMeBdSbyInBdaerxc;laCysorCpaopriatatel :uUnl.eSs.sCoothrperowraistesn;oMteudnaicnidpaalrse: represented by Broad Market:
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39
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Guide to the Markets ? U.S. Data are as of December 31, 2015.
This commentary is intended solely to report on various investment views held by J.P. Morgan Asset Management. Opinions, estimates, forecasts and statements of financial market trends that are based on current market conditions constitute our judgment and are subject to change without notice. We believe the information provided here is reliable but should not be assumed to be accurate or complete. These views and strategies described may not be suitable for all investors. References to specific securities, asset classes and financial markets are for illustrative purposes only and are not intended to be, and should not be interpreted as, recommendations. The information is not intended to provide, and should not be relied on for, accounting, legal or tax advice. Past performance is no guarantee of future results. Please note that investments in foreign markets are subject to special currency, political and economic risks. The manager seeks to achieve the stated objectives. There can be no guarantee the objectives will be met.
J.P. MORGAN ASSET MANAGEMENT 3
INVESTMENT INSIGHTS
TAXABLE STRATEGY
FIND THE APPROPRIATE MIX FOR YOUR FIXED INCOME PORTFOLIO
Institutional investors tend to broadly diversify their fixed income portfolios. Individual investors, who have historically diversified their equity risk, also need to ensure that their fixed income investments are appropriately diversified. When considering the right mix of investments, it's important to: ? Think strategically about augmenting your core bond holdings with complements and extended sectors ? Adjust allocations to reflect your market and interest rate outlook ? Consider your goals and risk tolerances
An appropriately diversified fixed income portfolio can potentially deliver better results and help investors achieve their goals with the right balance of market risk and opportunity.
Core
? Core bonds provide income and diversification to stocks, but rising rates and low yields present challenges.
? Active management mitigates risk by selecting bonds with the optimal mix of yield and return potential versus credit risk and duration.
Core Complements
? Strategies that seek returns uncorrelated to traditional bond markets and/or benefit from the impact of inflation can hedge downside risk and reduce volatility.
Extended
? Extended sectors can provide income and the potential for returns but can also be volatile.
? Corporate high yield bonds and bank loans typically outperform during periods of rising rates and economic growth but require frequent evaluation.
? Global bonds provide additional diversification and access to growth.
EXTENDED SECTORS Seeks income and total return
CORE COMPLEMENTS Seeks reduced correlations to core holdings
Emerging markets International/global High yield Bank loans
Absolute return Inflation hedge
CORE HOLDINGS Seeks lower volatility and diversification to equities
Sector-specific [Mortgage-backed, corporates, governments, etc.]
High-quality intermediate-/short-term
TOP-DOWN
BOTTOM-UP
Shown for illustrative purposes only. Because everyone's circumstances are unique, these models can provide a framework for discussion between you and your financial advisor. They should not be taken as one-size-fits-all investment advice. Asset allocation/diversification does not guarantee investment returns and does not eliminate the risk of loss.
4 ALLOCATION SOLUTIONS -- EVOLVING YOUR FIXED INCOME STRATEGY
PORTFOLIO ALLOCATIONS ARE DEPENDENT ON THE INTERACTION OF SEVERAL FACTORS
Goals
Interest rate and inflationary environment
Risk tolerance
Time horizon
Are you seeking capital preservation, income or a
combination of both?
Will, when and how fast will rates change?
How much risk are you willing to accept?
Are you focused on the short term or long term?
RANGE-BOUND
INTEREST RATE ENVIRONMENTS
SLOW RISE
RAPID RISE
INCOME
Extended 25?35% Emerging markets International/global High yield Bank loans
Complements 10?20% Absolute return Inflation hedge
Core 50?60% Intermediate top-down Intermediate bottom-up Short-term
Extended 30?40% Emerging markets International/global High yield Bank loans
Complements 15?25% Absolute return Inflation hedge
Core 40?50% Intermediate top-down Intermediate bottom-up Short-term
Extended 35?45% Emerging markets International/global High yield Bank loans
Complements 20?30% Absolute return Inflation hedge
Core 30?40% Intermediate top-down Intermediate bottom-up Short-term
GOALS
CAPITAL PRESERVATION
Extended 20?30% Emerging markets International/global High yield Bank loans
Complements 10?20% Absolute return Inflation hedge
Core 55?65% Intermediate top-down Intermediate bottom-up Short-term
Extended 25?35% Emerging markets International/global High yield Bank loans
Complements 25?35% Absolute return Inflation hedge
Core 35?45% Intermediate top-down Intermediate bottom-up Short-term
Extended 25?35% Emerging markets International/global High yield Bank loans
Complements 45?55% Absolute return Inflation hedge
Core 15?25% Intermediate top-down Intermediate bottom-up Short-term
Shown for illustrative purposes only. Because everyone's circumstances are unique, these models can provide a framework for discussion between you and your financial advisor. They should not be taken as one-size-fits-all investment advice.
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