The “Great Rotation” debate appears to be back. The term was originally coined by Bank of America Merrill Lynch (BAML) in 2011 and was used to describe the massive impending asset class shift of money moving out of bonds and into equities. This would have effectively signaled the end of the 30+ year bull market in bonds. Needless to say, since that time, the “Great Rotation” turned out to be a great marketing strategy but not a great investment strategy. However, since Trump’s election win, many investors believe the “Great Rotation” is finally upon us. With increased economic growth projections and rising inflation expectations, stocks have hit all-time highs and bonds have sold off sharply. Looking at the fund flows into fixed income, BAML notes that bond mutual funds and bond ETFs have seen outflows of -$30 billion over the past five weeks. This is the largest outflow since the “taper tantrum” of 2013.1
At this time, the team at Bramshill Investments does not have a strong opinion on this debate (although we acknowledge inflation risk is more of a real concern today). It is too early to tell. What we do have a strong opinion on is the market outlook for 2017. (In our Q3 commentary, we share some of our market insights.) In our conversations with RIAs, analysis of their strategic fixed income allocations has been an important topic for them. We agree that risk management in core fixed income is becoming a more critical component of an RIA’s due diligence and portfolio construction. Credit spreads remain fairly tight and interest rates are on the rise. The risks of severe drawdowns and capital losses have risen relative to years past. Going forward, we believe there are two important themes RIAs should consider: 1. Importance of active management in core fixed income; 2. Capital preservation.
In particular, at Bramshill, we were able to be defensive prior to the recent interest rate correction. We did not suffer a major drawdown as some active management peers, passive investment strategies, and benchmarks have suffered recently. We believe in 2017, Bramshill’s strategy will have many more opportunities. Interest rates have recently backed up 125 basis points, which causes some immediate pain, but also provides opportunity for higher overall yields and increased future returns. At Bramshill, we have been waiting for a correction like this to find new sources of quality yield across the five asset classes in which we invest: investment grade and high yield corporate bonds, municipal bonds, preferred stock and U.S. Treasuries. Tactical asset allocation and active management are key to take advantage of these opportunities and are paramount to our process.
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1Chris Dieterich, “Bond Fund Withdrawals Renew Chatter About ‘Great Rotation’.” The Wall Street Journal. December 6, 2016.