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By Jeremy Glaser and Timothy Strauts | 10-07-2013 02:00 PM

Key Themes for Fixed-Income ETFs

Panelists at the Morningstar 2013 ETF Invest Conference addressed trending topics of high-yield duration, bank-loan vehicles, near-term credit and interest-rate risk, and the tendency for bond ETFs to smooth volatility.

Jeremy Glaser: For Morningstar, I'm Jeremy Glaser. We recently wrapped up the ETF Invest Conference, and I'm here with Tim Strauts. He's a senior fund analyst, and he moderated a panel on fixed income and ETFs. We're here to get his take on the key themes in the bond industry. Tim, thanks for joining me today.

Tim Strauts: Glad to be here, Jeremy.

Glaser: Let's start with a high yield. It's obviously on a lot of people's minds. High yield has really seen kind of a wild ride during the last of couple months with all the talk of the Fed taper. What did you hear in terms of the attractiveness of high yield right now? Has this volatility been warranted?

Strauts: Well, what's interesting about high yield is that fund flows have been very strong earlier in the year, and then just recently in the last few months, we've started to see negative fund flows in the high-yield category. In general, the consensus of the panel was that high yield is still relatively attractive because the panelists generally thought that the U.S. economy was still improving. They thought the chance of recession in the near term was quite low. In general, the questions about the debt ceiling and obviously the government shut down, like most people, I think people at the conference generally though this is this kind of crazy with what's going on [in Washington]. But eventually [lawmakers are] going to come to an 11th-hour kind of agreement and that the markets really wouldn't be that affected by what's going on.

Glaser: The panelists were looking at the high-yield market. Do you think they were interested in taking on more credit risk, or was that duration risk that they'd rather take on with high yield? Where were they finding the most value in this space?

Strauts: What they would say is that they saw that definitely investors are shortening up their duration in high yield. A lot of the funds that look toward the shorter end of the yield curve and high yield are getting a lot of the fund flows. Actually they did say is that in the near term there might be more opportunity in the intermediate-term part of the high yield curve because so many investors are buying those short-duration bonds, that it's creating an opportunity if you're willing to go out a little bit longer in the intermediate space.

Glaser: So there weren't a lot of worries about credit?

Strauts: No. The default rates are averaging in around 2% right now, which is historically a very low level, and over the next two to three years [the panelists] were projecting ranges of 2% to 4% going forward. So no, default rates are not really a concern.

The one concern I guess I would have is that it seemed like everyone was on board, that everything was going be fine, and sometimes when everyone's in agreement, that's maybe not necessarily the time to bet with everybody.

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