Don’s Outlook 5/8/09
If you missed my conference call yesterday with Paul Frank, manager of ETF Market Opportunity Fund (ETFOX), you can listen to a replay of the call by visiting www.fidelityadivser.com or by clicking here: ETFOX Conference Call Replay.
This week, I would like to review another core holding, Federated’s Strategic Income (STIAX). Even as economic uncertainty drove investors from the equity markets, funds such as STIAX benefited in the wake of the flight to safety. STIAX, which has garnered a three-star rating from Morningstar, has helped investors capture returns in recent months despite the market slide. Year to date, the fund is up 13.28%, and over the last three months, the fund has gained more than 9%. As ongoing concerns plague U.S. financial markets and the world economy at large, bond funds such as STIAX that negotiate varying levels of risk could profit well into 2009.
STIAX uses three types of bonds—U.S. government, high-yield and international—to provide a high level of current income to investors. While the presence of high-yield bonds in the fund provides a greater level of risk to the investor, this risk can be tempered, in accordance with market conditions, by U.S. government investments.
In recent months, emerging-market debt and corporate debt have seen a resurgence. The top three holdings in STIAX are bonds from Brazil, Russia and Mexico. The slow stabilization of the peso and real against the dollar has helped investors gain the confidence needed to reenter these emerging bond markets.
Also among STIAX’s top ten holdings are bonds from eurozone countries France and Germany. As the European economic crisis deepens, more pressure is placed on the larger European countries, such as France and Germany, to consider bailout programs for smaller members of the union. Larger European bond markets are becoming more vulnerable, and as the bailout debate continues, analysts are reflecting on lessons already learned abroad.
The trillions of dollars flooding into the market from the federal government and the Federal Reserve will likely continue to tighten the spreads in corporate debt, potentially prolonging an upswing in the corresponding bonds. The riskiest bond investments will most likely benefit the most from the influx, and with 48.1% of STIAX classified as “high yield,” fund investors could continue to see the value of their shares rise as spreads tighten. At the same time, projected default rates on bonds rated B1a and below are expected to escalate in the next several years as companies facing bankruptcy and restructuring struggle to find financing. STIAX’s investors will face the rewards of tightening junk bond spreads and the increasing risk of default on some of the investments.
The intersection and interplay between the various bond types that compose STIAX make this fund a particularly interesting investment in 2009. USA Today recently noted that fund manager Joe Balestrino believes that lower Treasury rates could force pension fund and mutual fund investors to move out of Treasuries and into such other investments as corporate bonds. If STIAX continues to maintain an overweight position in high-yield securities, Balestrino could see his theory reap returns for STIAX investors in the months ahead.
