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Don't be so sensitive

Sure, interest rates are low in a historical context, but as of mid-September 10-year Treasuries were once again looking to top (and stay above) 3%. And thanks to the recent robust job numbers, the real questions are not if the Fed will continue tightening, but rather how much further and how fast.
Are you positioning properly
Given that backdrop, investors are right to revisit their fixed income allocations. Will bonds continue to play their traditional role in an overall investment portfolio? And if so, how should investors allocate their fixed income budgets?

For clues, investors may wish to look at duration. Duration is defined as a measure of interest rate sensitivity—the longer the duration, the more sensitive the investment is to shifts in interest rates and the greater its potential for losses in periods of rising rates. Floating rate bank loans may provide attractive risk-reward tradeoffs as evidenced by duration. 

As their name suggests, floating-rate bank loans are variable-rate loans made by financial institutions, generally to non-investment grade companies. Unlike most fixed income instruments, they can help balance an overall portfolio’s exposure to rising interest rates, providing greater price stability when compared with longer-term fixed interest rate bonds. This is due to their variable-rate yields, which adjust periodically, typically every 90 days, to mirror changes in market interest rates.

Moreover, bank loans are often ranked senior in a company’s capital structure, which means that, in the event of a default, bank loans are typically senior to bonds, convertibles, stock and other unsecured claims. In other words, these loans have priority for repayment and access to collateral.

Of course, there is no free lunch, and investors should always be aware of the risks associated with this asset class, including credit and liquidity. In fact, some common push-back comes from investors who wonder whether they are simply replacing duration risk with credit risk. That may be a viable concern given that bank loans are often below investment grade. Yet an active manager with deep credit research capabilities may be able to mitigate that risk by avoiding industries and individual companies with deteriorating balance sheets and higher risks of default. An active manager can also reject investments with inadequate liquidity.

All investments carry risks, but at a time when interest rate risk is increasing, investors should remember that floating-rate bank loans, which can offer attractive yields, are among the few fixed income assets that have the potential to maintain or increase in value in a rising rate environment. From this perspective, bank loans may prove helpful in structuring a fixed income portfolio.

Index definitions

1 Morningstar Bank Loan: Bank loan portfolios primarily invest in floating rate bank loans instead of bonds. These portfolios have credit risk and limited duration risk. The Morningstar Category Average is the average duration and average 30-day SEC yield for the peer group based on the durations and 30-day SEC yields of each individual fund within the group, for the period shown.

2 Morningstar High Yield Bond: High yield bond portfolios concentrate on lower quality bonds, which are riskier than those of higher quality companies. The Morningstar Category Average is the average duration and average 30-day SEC yield for the peer group based on the durations and 30-day SEC yields of each individual fund within the group, for the period shown.

3 Morningstar Intermediate Government Bond: Intermediate-government portfolios have at least 90% of their bond holdings in bonds backed by the US government or by government-linked agencies. The Morningstar Category Average is the average duration and average 30-day SEC yield for the peer group based on the durations and 30-day SEC yields of each individual fund within the group, for the period shown.

4 Morningstar Intermediate-Term Bond: Intermediate-term bond portfolios invest primarily in corporate and other investment grade US fixed income issues and typically have durations of 3.5 to 6.0 years. The Morningstar Category Average is the average duration and average 30-day SEC yield for the peer group based on the durations and 30-day SEC yields of each individual fund within the group, for the period shown.

5 Morningstar Multisector Bond: Broad bond portfolios that typically invest assets among several fixed-income sectors, including government bonds, corporate bonds, high-yield bonds and foreign bonds. The Morningstar Category Average is the average duration and average 30-day SEC yield for the peer group based on the durations and 30-day SEC yields of each individual fund within the group, for the period shown.
Consider the investment objectives, risks, charges and expenses of the funds carefully before investing. Download a prospectus or summary prospectus, if available, containing this and other important information for USAA Mutual Funds from, for Victory mutual funds from, or for VictoryShares and VictoryShares USAA ETFs from Read it carefully before investing.

Investments involve risk including possible loss of principal. The value of the equity securities in which the fund invest may decline in response to developments affecting individual companies and/or general economic conditions. Dividends are never guaranteed. International investing involves special risks, which include changes in currency rates, foreign taxation and differences in auditing standards and securities regulations, political uncertainty, and greater volatility. Emerging markets involve heightened risks related to the same factors as well as increased volatility and lower trading volume. You may lose money by investing. There are no guarantees the funds will achieve their investment objectives and strategies may be unsuccessful.

Investments in bank loans may at times become difficult to value and highly illiquid; they are subject to credit risk such as nonpayment of principal or interest, and risks of bankruptcy and insolvency. Fixed income securities are subject to interest rate, inflation, credit and default risk. The bond market is volatile. As interest rates rise, bond prices usually fall, and vice versa. The return of principal is not guaranteed, and prices may decline if an issuer fails to make timely payments or its credit strength weakens.

ETFs have the same risks as the underlying securities traded on the exchange throughout the day. Redemptions are limited and often commissions are charged on each trade, and ETFs may trade at a premium or discount to their net asset value. There can be no assurance that an active trading market for shares of an ETFs will develop or be maintained. The ETFs are not actively managed and may be affected by a general decline in market segments related to the Indexes. The ETFs invest in securities included in, the Index, regardless of their investment merits. The performance of the ETFs may diverge from that of the Indexes. 

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Judgments about a particular security, markets or investment strategy may prove to be incorrect and may cause an actively managed ETF to incur losses.

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Content on Xchange, the Victory Capital Blog, is not intended to be relied upon as a forecast, research or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. The opinions expressed are as of the date posted and may change as subsequent conditions vary. The information and opinions contained in each post are derived from proprietary and non-proprietary sources deemed by Victory Capital to be reliable, are not necessarily all-inclusive and are not guaranteed as to accuracy. This material may contain “forward-looking” information that is not purely historical in nature. Such information may include, among other things, projections and forecasts. There is no guarantee that any forecasts made will come to pass. Reliance upon information in this material is at the sole discretion of the reader.

This material does not constitute a distribution, offer, invitation, recommendation, or solicitation to sell or buy any securities; it does not constitute investment advice and should not be relied upon as such.  Investors should seek independent legal and financial advice, including advice as to tax consequences, before making any investment decision.

Victory Capital means Victory Capital Management Inc., the investment adviser of the Victory Capital mutual funds, USAA Mutual Funds, VictoryShares ETFs, and VictoryShares USAA ETFs. Victory Capital mutual funds and USAA Mutual Funds are distributed by Victory Capital Services, Inc. (VCS). VictoryShares ETFs and VictoryShares USAA ETFs are distributed by Foreside Fund Services, LLC (Foreside). VCS and Foreside are members of FINRA. VCS and Victory Capital are not affiliated with Foreside. USAA is not affiliated with Foreside, Victory Capital, or VCS. USAA and the USAA logos are registered trademarks and the USAA Mutual Funds and USAA Investments logos are trademarks of United Services Automobile Association and are being used by Victory Capital and its affiliates under license.

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