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U.S. Fixed Income

A Multi‑Sector Approach to Short‑Term Bonds

Michael F. Reinartz, CFA, Portfolio Manager

May build investment resilience through diversification and liquidity.

Key Insights

  • The low duration portfolio management team applies a multi-sector approach as we strive to capture an appropriate amount of risk-adjusted yield.
  • The multi-sector approach reduces the strategy’s dependence on any particular market and can help capture relative value across sectors.
  • Actively managing liquidity risk is a key component of our analysis of bond market sectors and the strategy’s allocations.

The low duration portfolio management team believes a multi‑sector approach is the best way for a short‑term bond portfolio to provide incremental income while taking less credit and interest rate risk than longer‑maturity fixed income portfolios. This reduces the strategy’s dependence on any particular market and can help capture relative value across sectors. We combine this approach with rigorous fundamental credit analysis to inform our security selection and help avoid downside scenarios as we strive to capture an appropriate amount of risk‑adjusted yield. Actively managing liquidity risk is a key component of our analysis of bond market sectors and the strategy’s allocations.

Multi‑Sector Approach

The US Short-Term Bond Strategy is an investment‑grade portfolio that can invest in a range of sectors, both in and out of benchmark. The Bloomberg Barclays 1–3 Year U.S. Government/Credit Bond Index benchmark includes Treasuries, agency debt, and investment‑grade corporate bonds.

The strategy also has the flexibility to invest in sectors that are not in the benchmark, such as securitized debt, which includes government‑guaranteed agency mortgage‑backed securities (MBS) as well as segments with credit risk, such as non‑agency mortgage‑backed securities (RMBS), commercial mortgage‑backed securities (CMBS), and asset‑backed securities (ABS). The drivers of credit quality in these securitized markets often differ from those affecting investment‑grade corporate bonds.

This multi‑sector approach provides diversification and allows us to take advantage of relative value opportunities based on the market environment and potential dislocations in valuation. When determining allocations across the various sectors, we can draw on the expertise of our global sector research specialists. We measure relative valuation in terms of yield or credit spread,1 adjusted for volatility to manage risk and help ensure that we do not simply chase riskier sectors that have been outperforming in a positive market.

We also diversify exposures within sectors. For example, within the strategy’s allocation to investment‑grade corporates, we manage exposure across industries as well as domestic versus international issuers. We are currently avoiding industries we think will experience negative structural change due to COVID‑19 (the disease caused by the coronavirus), such as travel and leisure. Within securitized credit, we can diversify across types of bonds with different cash flow structures and varying credit risk.

Credit Analysts Inform Security Selection

At the security selection level, we rely on T. Rowe Price’s global team of credit analysts to provide insight into the fundamental condition of individual issuers and the structures of specific bonds. Corporate credit analysts specialize in particular industries, while securitized credit analysts develop expertise in segments like RMBS and ABS. We believe that research input from the credit analysts adds value over time through strong security selection and enhances the strong foundation provided by our multi‑sector approach.

Active Management of Liquidity Risk

Liquidity in many fixed income sectors became limited in March as financial market participants realized the likely extent of the economic damage from the coronavirus pandemic. Although liquidity has improved meaningfully after the Federal Reserve implemented various programs to support fixed income market segments, we actively manage the strategy’s exposure to liquidity risk. This can help us navigate periods of extreme market stress, such as March 2020 and the depths of the global financial crisis in 2008–2009.

The different fixed income sectors have distinct liquidity profiles. Treasuries are the most liquid bonds, while investment‑grade corporates can present more challenges for buying and selling at efficient prices. We address this by laddering, or structuring the strategy’s corporate bond holdings so that they mature at regular intervals, and by generally favoring shorter‑maturity corporates for their better liquidity. We learned in March that securitized credit instruments can have surprisingly limited liquidity at times. However, unlike most corporate bonds, securitized debt pays down principal over time, which is another way to generate organic cash flow in the portfolio.

Structural Allocation to Treasuries for Liquidity

Liquidity considerations are a key component of our multi‑sector approach. The strategy has a structural allocation to Treasuries that should benefit from their liquidity even when trading at efficient prices in other sectors becomes limited. In addition, we ladder the portfolio’s corporate debt exposure in seeking to provide the strategy with predictable small increases in cash without relying on selling holdings.

What We're Watching Next

As always, we rely on rigorous fundamental analysis to drive our investment decisions. We are closely collaborating with our corporate credit analysts and global economists to gauge the impact of the coronavirus pandemic on corporate earnings. Amid the ongoing uncertainty about the pace of reopening businesses and the economic recovery, the range of consensus expectations for corporate earnings has grown much wider. We believe that this may produce more opportunities to find individual corporate bonds with prices that do not accurately reflect their fundamentals.

1 Credit spreads measure the additional yield that investors demand for holding a bond with credit risk over a similar‑maturity, high‑quality government security.

Important Information

This material is being furnished for general informational and/or marketing purposes only. The material does not constitute or undertake to give advice of any nature, including fiduciary investment advice, nor is it intended to serve as the primary basis for an investment decision. Prospective investors are recommended to seek independent legal, financial and tax advice before making any investment decision. T. Rowe Price group of companies including T. Rowe Price Associates, Inc. and/or its affiliates receive revenue from T. Rowe Price investment products and services. Past performance is not a reliable indicator of future performance. The value of an investment and any income from it can go down as well as up. Investors may get back less than the amount invested.

The material does not constitute a distribution, an offer, an invitation, a personal or general recommendation or solicitation to sell or buy any securities in any jurisdiction or to conduct any particular investment activity. The material has not been reviewed by any regulatory authority in any jurisdiction.

Information and opinions presented have been obtained or derived from sources believed to be reliable and current; however, we cannot guarantee the sources’ accuracy or completeness. There is no guarantee that any forecasts made will come to pass. The views contained herein are as of the date written and are subject to change without notice; these views may differ from those of other T. Rowe Price group companies and/or associates. Under no circumstances should the material, in whole or in part, be copied or redistributed without consent from T. Rowe Price.

The material is not intended for use by persons in jurisdictions which prohibit or restrict the distribution of the material and in certain countries the material is provided upon specific request. It is not intended for distribution to retail investors in any jurisdiction.

Canada—Issued in Canada by T. Rowe Price (Canada), Inc. T. Rowe Price (Canada), Inc.’s investment management services are only available to Accredited Investors as defined under National Instrument 45-106. T. Rowe Price (Canada), Inc. enters into written delegation agreements with affiliates to provide investment management services.

Morningstar Awards 2020©. Morningstar, Inc. All Rights Reserved. Awarded to T. Rowe Price for 2020 U.S. Morningstar Exemplary Stewardship and to Jerome Clark for 2020 U.S. Morningstar Outstanding Portfolio Manager, U.S.A.

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