Best part of the current credit market

In the current environment, the best part of the credit market is securitized credit, says Jeffrey Gundlach, CEO of DoubleLine Capital in Los Angeles, Calif., and manager of the Renaissance Flexible Yield Fund.

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That’s because investments such as banks loans and commercial mortgage-backed securities have been lagging unjustifiably, says Gundlach. “What’s good about these investments [today] is not only are they cheap but they’re also focused on floating rates. If the Federal Reserve raises rates and if investors are concerned about [further hikes], floating-rate securities completely protect [them]. As rates rise, the cash flows from the securities increase and there isn’t really any price loss because their floating-rate nature makes their prices stable, even as rates fluctuate.”

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Also, “with the rebound in oil prices, we’ve seen a [rally] in corporate junk bonds and some strong return in emerging market debt, which we have invested heavily in within our flexible yield strategy,” he adds.

Read: Are high-yield bonds still junk? and Should you judge a bond by its label?

What to do when rates rise

“If you [choose] a flexible income strategy or low-duration bonds as rates rise, your returns will probably be higher if you look forward over, say, a five-year horizon,” says Gundlach. This is worth considering once the Fed carries on with its rate-hike plan and as we exit the “environment of stable rates that we’ve been in for the past five years.”

He adds, “Low-duration bonds are always the place to be during a rising-rate period.” The benefit is the cash flows of low-duration bonds “will increase as rates climb and as their maturities roll off, and they won’t experience high principal losses along the way.”

Read: Understand duration for better bond returns

Low-duration bonds come in two flavours. The first is floating-rate, and this type has “become attractive as we’ve started to see improvement in their cash flows.” Then, there are “bonds that simply have shorter maturities dates, such as a two- or three-year maturities.”

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In particular, “[The latter type] has been a significant part of our flexible yield strategy and probably always will be,” says Gundlach. That’s because “if you have a two- or three-year maturity bond, its price can fluctuate over that period. But its maturity will take you out at 100 cents on the dollar, or full value, in a relatively short period. Then, you can reinvest that maturity at a higher interest rate.”

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