Bond Investing, Beyond Yield: A deeper dive

MATT WELLS: Hello, everyone, and welcome to today's webinar, bond investing beyond yield-- a deeper dive. I'm Matt Wells, a fixed income regional brokerage consultant here at Fidelity. In today's session, we'll examine current economic trends shaping fixed income investing and explore strategies for building a bond portfolio in today's changing rate environment. Joining us now is today's presenter, Danielle Fox, another fixed income brokerage consultant here at Fidelity. Danielle, welcome to the broadcast.

DANIELLE FOX: Great, thanks so much for having me. It's good to see you, Matt. Thanks to everyone for making the time today.

MATT WELLS: Nice to see you as well, Danielle. Thanks for joining. Why don't you get us started?

DANIELLE FOX: Perfect. So I'm going to be referencing this throughout the presentation. But one of the main aims of today is to really focus on creating a sustainable and repeatable process based on how you like to invest. Professionally, I have a background in the fixed income market. And a lot of that was really rooted in the idea of trying to have a sustainable and repeatable process. So I want to make sure to articulate that as something important today. We will talk a little bit about resources that are available for you to consider. But this is definitely not an exhaustive discussion of everything that one would want to know in the bond market.

So let's take a peek at today's agenda so we can see what we're going to be prioritizing today. And we're really going to be focused on four key areas. The first is a bit of an economic backdrop. So this will have some more recently updated slides that are timely. We've got a Fed meeting coming up this week, which is obviously a big deal in the bond market. So we can address that if any questions come up. And then, we'll talk through three dimensions of fixed income investing that Fidelity believes is quite important. I share that view as well.

And then, we'll take a deeper dive, as the title indicates, into municipal and corporate bond investing. We'll wrap up briefly, a little bit, on tools and strategies. Part of the reason I prioritize that lesson, this content, is there are other sessions and videos in our learning area that are dedicated to that more specifically-- so again, some kind of a judgment call there. So let's go ahead and dive into the first aspect of the content today, and really thinking through the macroeconomic backdrop. Say that 10 times fast.

So there's a lot on here. So this is a great reason, again, why to download slides if it's something that you want to take away from today's session. But we've got S&P making highs, up 10% year to date. And we've had some very hot IPOs recently. And it looks like the pipeline is set to continue there. So there's a lot going on in the equity market. But as I alluded to in some of the opening comments, we now have a new Fed chair.

Kevin Warsh has been appointed to replace Jerome Powell. And that transition is, perhaps, going to create some uncertainty. But one of the key takeaways I would have from this slide is that the Fed is widely expected to raise rates by the end of the year, potentially once, by 25 basis points, or a quarter of a point, potentially twice, for a total of 0.5%, towards the end of the year. As we get closer to the end of the year, we not only have the Fed meetings to contend with in terms of learning more about the new leadership.

But you'll notice that Jackson Hole is something that the last bullet point talks about. That's later, towards the end of the summer. And very commonly, this has been a speech where prior Fed chairs have used it to telegraph certain policy changes that might be coming as we head into year end. So as we get into late August, you definitely want to pay attention to what's going on with the Jackson Hole speeches, as that is something that could influence how we think about the rest of the year.

But the last thing I'll mention here is longer-term interest rates, which are kind of remaining higher for longer, and stickier at these elevated levels, are really a function of inflation remaining sticky after rising for the third straight month in May with the recent CPI number. So we could be looking at different parts of the yield curve acting in different ways, which is something that we'll talk about in the dimensions piece of this presentation. So that's a little bit about some of the key takeaways that I would have from this market driver slide.

What we're looking at here, in this slide, gets a little bit skewed because of what happened in 2020. But we're looking at the unemployment rate and core CPI, which is inflation. And these are two mandates that the Federal Reserve has as part of what guides them, going forward, with interest rate policy. The employment rate has remained relatively sound. The labor market has reaccelerated a little bit here, which we'll see in one of the slides going forward. But the two-year Treasury note, which is really tied to the Fed funds rate, you're seeing in that light blue, has stabilized a little bit after having fallen a little bit in anticipation of some rate cuts rather than rate hikes. So we've really had this pivot happen.

This chart gets-- with the long view of it, sometimes the noise, in the short term, isn't always as obvious. So I actually want to take a look at the next slide around trends, which kind of compresses that view a little bit. And there's some interesting bullet points on the left-hand side, which folks can see around past rate cycles and things of that nature. But again, the labor market has reaccelerated. But what you'll notice here is there are some pretty interesting correlations that go back.

First of all, the Fed funds rate, in light blue, and the two-year Treasury, which is in that kind of olive green color, tend to be very highly correlated in a positive manner, meaning that the Fed's rate hikes and rate cuts tend to affect short-term interest rates more so than long-term interest rates. The 10-year Treasury, which is that navy blue color, tends to be more tied to the fundamentals of our economy. So as we think about the Federal Reserve, while a new Fed chair is important, and policy might be changing-- and all of those things have cascading effects for the economy-- in terms of what it tends to affect from an interest rate perspective is the shorter-term part of the market, which I'll broadly define as two years in it. So that's a little bit about some of the trends here.

MATT WELLS: Danielle, I'm hearing a lot from clients around the new Fed chair and the impact on rates. And I know you shared a little bit around the market expectations moving forward. But can you shed a little more light around what investors should be looking out for with the new Fed meeting coming and the impact on rates moving forward?

DANIELLE FOX: Sure. So the change in leadership is happening at a rather interesting time where, frankly, regardless of who the Fed chair was, the idea that we were going from a rate cutting cycle to a rate hiking cycle was probably going to happen, whoever was at the helm. But that being said, obviously, folks in Washington would ideally like the Fed to be cutting interest rates, making mortgage rates more affordable, things of that nature. But the inflation piece, which is outside of the Fed's control in terms of the cost of goods and services, that rising and remaining elevated is really going to force their hand to raise rates, regardless of what someone says in a confirmation speech or not.

Optically, though, it would be very challenging for a Fed chair to cut rates right now. And it would question, potentially, the Federal Reserve's independence, which is really one of the hallmarks of first-world economies and marketplaces that foreign investors want to invest in. So the projection of independence is extremely important. And I think that's something that is going to be reinforced throughout some of these upcoming speeches and opportunities to share what's going on within the Federal Reserve.

The last thing, Matt, that I'll mention from a content perspective is that we're also getting a more divided Fed in terms of how members are voting. And Kevin Warsh, the incoming Fed chair, has said he welcomes that divisiveness. So that is something that I think we should potentially expect, which might be slightly different than what we've-- it is slightly different than what we've been accustomed to in the past.

MATT WELLS: Thank you.

DANIELLE FOX: Yeah, no, that's a great question to bring up in terms of thinking through what we're hearing from investors. So I'm glad you took the chance to ask that question. Now, one thing I find intriguing about this slide-- and there's a lot of numbers on here, so I kind of want to focus on certain key takeaways. Obviously, we all have recent memory of 2022 to 2024, when the Federal Reserve embarked on, really, an unprecedented rate hiking cycle in a relatively short period of time.

And so it's one of the few points in time where both the stock and the bond market were down for calendar year 2022, which is quite unusual, for both asset classes to be negative in a year. So I want to acknowledge, obviously, that that occurred. But if we were to, say, strip that out, one of the takeaways that I like about this-- if you look at the right-hand side, if we are truly embarking on a Fed rate hike cycle, the magnitude of those rate hikes, I think, is quite unclear. We talked a little bit about market pricing for one to, potentially, two rate hikes before the end of the year.

But I think one of the challenges that investors often face is, if the Fed is raising rates, I can't make money in bonds, or I can't have a positive return. And so one of the things that I would invite folks to take a peek at here is that, yes, 2022 to 2024, a lot of things didn't do well that year, 2022 specifically. But it is possible to make money in fixed income when the Fed is raising rates. Because it really centers around not just our rates going up or down, but what is the pace of that change and the magnitude of the change, and whether or not you, as an investor, have an opportunity to keep up. So just wanted to point that out as one of the takeaways from that slide.

Again, a lot of noise on there in terms of lots of different numbers. So that's a little bit about the backdrop, so the first section of what we were planning to cover today. And then, I wanted to focus on the three different dimensions of fixed income investing that, as you go deeper into the bond market, are going to be awfully important-- understanding how the yield curve is structured, how sub-asset classes work, which I would almost think of like sectors in the equity market, and then, within a certain segment of the market, that there is no free lunch, and risk is part of the evaluation.

So there are three slides in quick succession, describing the different types of yield curves that we have. The first one, a steep yield curve, or an upward-sloping yield curve, is what most investors would expect. As time goes on, you're going to give me more money for relinquishing access to my money for less time versus more time. So I want to get paid for the cost of waiting. And so this is a bit of what we have going on right now, not as steep as this. It isn't always perfectly symmetrical like this.

So you can have a flat start and then pick up a hockey stick a little bit, which is-- we have a moderately upward sloping yield curve. You can have, as we did in the summer of 2019, an inverted yield curve in which short-term interest rates are higher than long-term interest rates. And historically speaking, this has been nearly a 100% accurate predictor of a domestic economic recession. So if you think about it, August of 2019, before March of 2020, when, obviously, the COVID pandemic really took off and put us into a global recession, the market didn't know what was going to cause a recession, but it was pricing in a recession even before the pandemic occurred. So again, an inverted yield curve, historically, has been an awfully accurate predictor of a domestic economic recession.

And then you can have a flat yield curve. And this is a scenario in which it's hard to see value in going out further is probably the best way to think about it. It's usually towards the end of a rate cycle. The Fed is still raising rates. Growth is relatively strong. So this might be something that we start to see as we get through the beginning stages of a rate hike cycle with the Federal Reserve, where that moderately upward-sloping yield curve is a bit flatter. And this would often precede an inverted yield curve that we saw on the prior slide.

So we've got that steep, inverted, and flat. And those tend to show up at different parts of the economic cycle. So it's a way for the Treasury market to provide some insight as to where they think the health of the domestic economy. So that's the first dimension, having a little bit of awareness around the Treasury yield curve.

The second-- and this might actually, I think, be my favorite slide. And I know I've done this presentation before. So if you've seen it, you've probably heard me say the exact same thing previously. But what I like about it is, again, the example, or the analogy, that I would use is that sub-asset classes of the bond market are kind of like sectors of the equity market, different pockets of the market. And what we have here, from left to right, is, for the most part, looking at your most risky types of securities in terms of default risk. And then, as you trend further to the right, you're looking at, in theory, your safest, or most creditworthy, assets.

So just to give a little bit of a description of some of the abbreviations-- so HY here would be high-yield corporates, which is a really polite and diplomatic way to say junk bonds. IG corporate, third one in, is investment-grade. So these are your more creditworthy companies. MBS is mortgage-backed securities. And the US aggregate is kind of like your S&P 500 of the bond market. It looks at a cross-section of Treasuries, investment-grade-quality corporates, and mortgage-backed securities. So it's a multi-sub-asset class index. So this is kind of what you're looking at here in terms of the left to right.

What's important to note is when you think about fixed income, the lower in credit quality you go, the more that bonds start to act like stocks is really what this chart-- if I were trying to give a takeaway, the lower in credit quality you go, the more bonds start to act like stocks. Emerging markets is foreign junk. High-yield is domestic junk. And then, you've got investment-grade-quality corporates.

So in 2008, if I had been concerned about the global financial crisis, and I had put money into a high-yield bond fund, or an ETF, as an example, and I had a negative 20-something percent return, I'm going to feel something somewhat similar to what I would have experienced in the equity market. Now, hopefully, they had stuck around for the rally in 2009. But that disparity of returns is very consistent with what one would have experienced in the equity market, versus, on the far right-hand side, you've got US Treasuries, where the bandwidth of returns is much narrower.

So as you think about the role of fixed income, is it about creating wealth or keeping wealth? The left-hand side is more about trying to create wealth. That knife cuts both ways. US Treasury, the further to the right are, it's more about keeping what you have. So not all bonds are created equal. But again, the lower in credit quality you go, the more bonds start to act like stocks. So if we start thinking about focusing solely on yield, there are cascading effects to that. So just important to be cognizant of that.

So that's dimension two. So not all sectors or sub-asset classes are created equal. And the quality piece is going to be very impactful in terms of what your correlations to the equity market might look like. Within a category, there's going to be a range as well. So this is our fixed income landing page, which is a great way-- when you are signed in, and you go to news and research at the top of our website, and then halfway down, fixed income bonds and CDs, and you scroll about halfway down, this chart is going to appear. And what I love about it is it allows me to very quickly say, what does the bond market look like today?

This is organized by the highest-yielding security in any given category for the time horizons displayed, which are a cross section. So you're looking at the highest yield. Now, with something like a US Treasury, that's not going to be as big of a deal. But as this presentation gets more into corporates and municipals, you're going to see that, within the corporate market, or within the municipal market, you're going to see a dispersion of yields, even within a ratings sector.

So for example, here we are, looking at five-year securities, going out to 2031. And-- excuse me-- we're looking at AA-rated securities. So Meta, NVIDIA, Lilly are all listed on this page. But what you'll notice on the red box is it's looking at, if I wanted to buy securities, what would my yield be if I obtained it? And you'll notice that there's almost a half a point difference, percentage-wise, between the top-yielding one and the lowest-yielding security.

So even within a ratings category, you will see a bit of dispersion in yield. And one of my former bosses used to say this. It was the famous line from Ronald Reagan, trust, but verify. The further you are above the median yield, which you see here, in the middle of the page, the market is saying, is this always going to be a AA-rated bond? It's trying to think ahead about what its future rating might be. And if it is distrusting of that rating being sustainable, then you'll start to see yields, perhaps, float higher. So that's a little bit about how to think about, within a category, looking at yields, and trying to think through it as you're making an investment decision.

If I were to take that a step further-- and let's talk a little bit about corporate bonds more specifically. And then we'll spend some time talking about municipal bonds. And some of the slides are going to have some similarities. Obviously, the corporate market and municipal market are, structurally, a little bit different. Taxes are different when you have to worry about that as well. So there are going to be some things that are a little bit different. But I'm going to try to show some consistency between the two when possible.

So what's interesting here-- remember, from that prior slide around sub-asset classes and not all bonds are created equal, you're looking at spreads. And a nice way of talking about spreads is, how much am I getting over a Treasury yield, is really what a spread is. The Treasury market is your risk-free rate. It's the benchmark for risk. And on the left-hand side, you're seeing, for the last 20 years or so, how much, over a Treasury yield, the investment grade market has paid, and on the right-hand side, the junk bond market, which we're politely calling the high-yield market.

These two charts look the same. It's worth noting that the vertical axis is different by a factor of 3. So when you think about the difference in yield, and trust but verify, as Reagan used to say, the investment-grade market and the creditworthiness of that is far more trusted than, say, the say, the junk bond market, where you frankly, to some extent, become a little less interest rate sensitive and more economically sensitive. If a company is not as creditworthy, yeah, you care about what the Fed's doing and things of that nature, but you're more concerned about their business. And are they able to sell enough widgets or provide enough services in order to pay their debts?

So you start to become more fundamentally focused, which is why there can be that correlation to the equity market. So might look the same. Factor of 3 is the big takeaway here.

MATT WELLS: Danielle, you shared how spreads-- that is, the difference in return between different types of bonds-- are really tight right now. So how could a client use that information to guide them as they're considering different bonds to invest in?

DANIELLE FOX: Sure, it's excellent question. I think, Matt, you and I probably spend a lot of time coaching clients on some thoughts, or a little bit, procedurally, about how to think about it. Obviously, everyone's risk tolerance is going to be different. But as you get later into the economic cycle, you actually want spreads to be a bit wider than they are right now. So when you talked about them being tight, it's relative to the current state of the economic cycle that we're in. So as we move later in the economic cycle, you'd actually want the amount that you're getting, over a Treasury, to be higher than it is right now.

But that being said, every individual investor has to think through a decision, which is, if I'm going to leave the shallow end of the pool-- and what I mean by that is, if I'm going to give up FDIC insurance through a CD on our platform, or a Treasury that has the full faith and credit of the government, how much extra do I need, in this part of the economic cycle that we're in, in order to feel like it's worth it? Matt, you and I might feel like spreads are tight. But if someone's got a number in their head, and they're comfortable with it, I'm not here to say that that's a bad idea.

But what I'm about to say could sound a little bit like market timing, but it is not intended to sound like that. Where you often, from a portfolio construction perspective, will start to think about introducing corporates more is when spreads have widened out, so the amount you're getting compensated over a Treasury yield. And that actually might be when you're in a recession, versus later in the economic cycle. Again, not to sound like market timing, but this is when you're thinking about rebalancing within the sub-asset classes, how you might think about it.

Because the one last thing I'll mention around this is that downgrades and defaults tend to lag a recession, not lead it, historically. So you don't want to be going full-throttle into this and take your foot off the gas in terms of monitoring. Because we've gone through a recession in a future state, and you think you're in the clear. So I guess those are some comments related to that. Anything you think I missed, Matt?

MATT WELLS: No, I think it's also really helpful, to your point, as you evaluate whether it's worth it or not, to compare those spreads manually. Look at what the bond is paying that you're looking at, and compare that to a Treasury, for example. And that can give you a real comparison of the two in a real life example.

DANIELLE FOX: Right, exactly. Because if I'm able to get 4.25% on something that's either full faith and credit or FDIC insured, and my alternative is 5%, the audience, that 0.75%, some may say, yes, that's totally acceptable, or no, it's not. And part of that is informed by your own personal risk tolerance. So I love the question. But even when spreads are tight or wide, someone's risk tolerance may not support it. And so that's also part of the evaluation.

And when we talk about credit risk right-- and I talked about trust but verify-- one of the things, structurally-- for example, this Crown Castle bond here, I see that it's BAA3/BBB. So it's on the lower end of the investment-grade spectrum, which is not unusual given where the average credit quality of the corporate bond market is. But if this were a higher-yielding security-- it looks like it has a 5% style yield. And you say, all right, is this going to be something that I'm comfortable with? You always want to look at material events, especially if something is floating above the median yield. You're getting paid extra versus its peers. Again, trust but verify. This issuer was downgraded by Fitch.

Now, they also removed them from a negative credit watch. But what you'll see is that there's a fair amount of potential ratings action that has been at risk over time. So any material event will include outlook changes, credit watches, which means it's seriously being considered for an upgrade or a downgrade, and then the actual ratings event itself, upgrade or downgrade. Obviously, everyone will take the upgrade. We're trying to manage the downside risk around downgrade.

So material events-- when something looks maybe a little too enticing, is the trend your friend from a quality perspective? It's very much worth noting. So this is information that's always made available on the website. In addition to thinking about the credit quality, it's also liquidity. Because I may buy this security with the idea to own it the full five years. But if something happens from a ratings perspective, or I have a life event where I need to access capital prior to July of 2031, I want to make sure that-- at least a point in time evaluation, that-- there's an active, what we call, two-sided market, meaning multiple firms making offers and bids available, so that if I need to buy or sell a security, that I don't incur a lot of friction in order to do so.

And so that's what depth of book allows you to do, is access multiple sources of liquidity, both to sell on the bid side and to buy on the ask side. And that's a little bit related to how Fidelity has opted to build out their platform, leveraging the inventory of others. So that's a little bit on the corporate side.

With this, we'll actually transition into the municipal market, which, of the two markets, from a quality perspective, that we're talking about today, this is, generally speaking, the higher credit quality market. When you think about municipals, obviously, you want to make sure they're suitable. So non-retirement account dollars for your traditional tax exempt debt. And you want to make sure that your tax bracket and time horizon are supportive of it as well. But when we think about the municipal market, at times, it, on many occasions, will march to the beat of its own drummer.

And this chart does a good job of talking through some of those events that are very unique and specific to the municipal market, whether it's the tax-exempt status of municipals being in jeopardy-- it seems like there's always like a court case here or there that comes up that wants to challenge that-- the bond insurance saga, where Ambac, MBIA, in the financial crisis, and other bond insurers, kind of got themselves into hot water for insuring things that weren't municipals, that had losses on derivatives, and things like that-- and then, you get a few bankruptcies here and there.

Detroit's probably the most notable in recent history, Puerto Rico. There's been a few. And so all of these things can create some volatility in a more fragmented market. But when you look at this, we're looking at the 10-year Treasury yield in olive and the AAA 10-year municipal yield in dark green. So Treasuries are federally taxable. Municipals are federally tax-exempt. And so oftentimes, what you'll look at is-- yields are high or low compared to something. So what's your something? More often than not, it should be a Treasury. But looking at municipals on a relative basis versus an absolute because of that tax difference.

And so when I started in our capital markets area of Fidelity, which unfortunately predates this slide now-- but it was like, if you could get 80% of municipal yield-- I'm sorry, 80% of a Treasury yield-- in the form of a municipal yield, that was a good value. And so there are points in time where that is very doable. And then, there are points in time where it is not. Right now, we're probably on a slightly more expensive side than 80%, at least at 10 years. And that's in the face of record issuance.

There is also record demand. There's a lot of states that have passed higher income taxes. And so there's definitely been demand there. High-quality municipals, there's a lot to go around, and everyone's scooping them up. So the relative value is not as historically favorable, but it doesn't mean it's unfavorable. It's all relative.

And as we talked about previously, with the corporate market, within a ratings category, and within a maturity set, there's going to be a wide variety of yields. Again, trust but verify. Market's trying to price in certain types of risk, credit risk, things of that nature. Here, we're looking at, let's call it, 10-ish year municipal bonds. And we're looking at California. And you'll notice that they're a little over 10 years, 10 years of call protection. And yet again, you've got a variety of different yields attainable.

And a lot of these have somewhat similar structure. So if coupons are similar, maturity dates are similar, and the call dates are similar, the ratings are sort of similar, the big difference is an evaluation of the issuer itself, and then probably, to some extent, how much debt is outstanding in the bond, and things of that nature. But you will notice, there is quite a dispersion, in this case, 0.75%. This one's not sorted by yield. But there's a yield to call it 2.60% and one at 3.38%. So you've got a wide variety to choose from. So again, a bit of a dispersion in terms of the credit quality that-- or I'm sorry, yield, that-- you're going to see within a similar credit quality.

So if the market has that big of difference in terms of thinking about, potentially, risk, ratings and material events are going to be extremely important in the municipal market, especially when you think about, there's, what, 8,000 publicly traded companies. And there are hundreds of thousands of different issuers across all 50 states and the provinces. So with that being said, if we look at, for example, the St. Lucy bond, it is insured by Build America Mutual, which is one of the insurance companies.

And so when you are dealing with an insured bond, the ratings can be kind of twofold. One is an underlying rating, which is, what is the standalone issuers-- or the issuer's standalone rating? So if I strip away the insurance, St. Lucy, what is its own rating? OK, A2, A, based on Moody's and S&P. Build America mutual is a bond insurer providing credit enhancement. I would liken this to, this is like car insurance, not health insurance. When you use this insurance, or when it's leveraged, something bad has happened, versus health insurance, where you know you're going to use it.

So if I'm looking at the Build America bond-- Build America Mutual, not Build America bond, but Build America Mutual-- rating, the AA rating by S&P is indicative of Build America's rating. So that's what it gets enhanced to. So when you're looking at a rating set, it's always going to show you the higher of the two initially. But then, you want to dig deeper to say, all right, is there a drop in standalone credit rating? And is that something that is going to positively or negatively impact my investment decision?

So I'm personally a believer in, you buy a bond based on its underlying rating, not what it gets enhanced to. Because I don't want to be using this insurance. And as I'm looking at this, I also want to make sure that I'm taking advantage of looking at material event notices, again, around changes in credit quality with the issuer. Is the trend my friend, especially if it's kind of floating to be a bit of an outlier, from a yield perspective, on the high side?

It's also important to take a look at how a security is trading. I know we're talking about municipal bonds right now. So this chart is of a Boeing bond. But it is showing a chart of where it's traded recently. The reason we're using a corporate bond is a corporate bond trades a lot more actively. Sometimes you can go months, if not years, in between municipal bond trades. But you can look at this either in a table view or a chart view. And it's awfully important to focus on recent trades that are on the same side of the market as you are. So if I'm a buyer, where someone sold a bond two weeks ago is probably not going to be all that helpful. So I want to be recent, and on the same side of the market as I am, which kind of gets to-- and I had, alluded to it earlier, in terms of how Fidelity has chosen to build their platform. But we view this as an opportunity to provide value to clients in the fixed income space. And it's long been a decision of Fidelity to keep the cost of accessing the market to a bare minimum if you're going to be doing this on your own. So when you purchase a corporate bond, or you purchase a municipal bond, one bond, $1,000 maturity value, Fidelity is going to charge you $1 to either buy or sell it. The prices that we've shown on the website are prior to that commission. So if you're buying it need to add 0.1. If you're selling, you need to subtract 0.1 to account for that dollar, which is a very different business model and cost structure from what our competitors have opted to do, which really try to view it as a revenue source for their own businesses.

MATT WELLS: Danielle, the top question that I get from clients when we talk around Fidelity's bond pricing is, how are we able to offer a much lower commission for purchases than some of our competitors?

DANIELLE FOX: Yeah, great question, Matt, definitely one that I will run into a lot as well. And so the analogy that I will use is, think of the Fidelity bond offering as going to Amazon. And what I mean by that is, if I went and ordered dish soap, or whatever it is, Band-Aids, from Amazon, sometimes Amazon is fulfilling that order. Sometimes it's a third party. Because I might want to shift quicker if someone's offering a better price. There's certain qualitative attributes, or quantitative, where these different market sellers are competing for my purchase of Band-Aids or dish soap.

And so if you think about it, Amazon is the portal, but they're creating this marketplace where other folks can participate in selling their products. Same concept at work. So why is that important? Well, if Fidelity is leveraging other firms' inventory, and there's a couple hundred behind the scenes, then we're not committing capital to make all this inventory available. And that's where cost comes in. It takes capital to display that inventory.

So if we're your portal, in that case, if we're your Amazon, and we're allowing you to canvas the market for publicly available bids and asks, depending on which side of the market that you're on, we're not committing capital in order to make those prices and availability straight to you. So it's just straight-through pricing. So as a result, it allows-- if we're not committing all that capital, it allows us to keep the cost of accessing the market and using other firms' inventory to a bare minimum, really. And so that's how we're able to charge $1 per bond is because we've opted to leverage technology.

I think, for a lot of Fidelity clients, you notice this in other parts of our website and offering, that we are a digitally scaled company. And this is no exception. And this is the benefit of it, is that if I'm going to be taking the risk of owning a 10-year municipal bond, like on that prior slide, in California, I want to be able to keep as much of the yield as possible. I don't want to be in a revenue sharing agreement. So this is a great value for clients. So thanks for asking that question, Matt.

So we're at the fourth bit here, where we talk a bit about strategies and tools. As I mentioned, I'm going to fly through this, because I want to make sure we get to Q&A. And there are other videos and archive webinars that get into some of the tools that we have. So in the interest of time, I'll say, go check it out. So these are some things that you can think about when trying to solve for asset allocation and why I might use fixed income, whether it's interest rates or saving for college where certain tuition expenses might occur, and you know the timing of them. And there are two tools, the ladder tool and the dashboard, both of which have archived webinar events and videos that you can dive into further. So I'm going to gloss over that for a second to say, all right, well, if I buy bonds, what am I doing in the simplest of terms is I'm investing a certain sum of money today in one or a series of bonds, and they're going to pay me periodic interest, more often than not, semi-annual, but not always.

And then, on maturity, or at a call date, if it's callable, I might get my return of principal early or at the stated maturity date, along with my final interest payment. So you're seeing that sequence of cash flows in and out. And then, as I do that over and over again with different bonds, I get a ladder, where I have staggered maturities, staggered interest payments, and things of that nature. So you're seeing an annual view of that. You can also view it as a monthly.

Since we might be in an inflation environment and rising interest rate environment, one of the things that you might elect to do is stick to shorter maturity so that you get a higher velocity of turnover. And you get to capture those higher interest rates in a rising rate environment sooner rather than later. So that's really the concept of staying shorter if you're concerned about rising interest rates. The shorter that you stay with the ladder, the more you're telling me you think rates are going higher or staying higher.

So as we get to the Q&A here, we've talked, about a lot-- economic trends, three types, or dimensions, of bond investing, understanding the yield curve, not all sub-asset classes are equal, and then, even within a sub-asset class, a wide range of yield. So really gets into the idea of doing your research from a credit evaluation perspective. We talked a little bit about the municipal and corporate market, and some of the transparency that you can have around it due to ratings, pricing, and things of that nature, and a bit of a sneak preview on some of the tools and strategies that one could consider knowing that there's more content elsewhere on the website.

When you go to our website, you can learn more about our fixed income tools through Fidelity.com, at fixed income, and looking at our bond tools section, our research page. There's archived events, some of the titles that you see listed below within our learn section. So there's a lot of additional content that one would have access to. Obviously, sometimes you have questions, and you want to give someone a call. So our fixed income team is available at the number listed below, 8:00 AM to 8:00 PM, Monday through Friday. We also have the local financial consultants in our different offices, nationwide, that are available to talk through how something might fit in with your fixed income strategy.

I guess, with that, I don't know if we want to turn it over to some Q&A with the last 10 minutes or so.

MATT WELLS: Absolutely, let's do it. Danielle. Thank you for the presentation. And we do have a lot of questions coming in. So we'll do our best to get through those. And I'll try to consolidate some to hit multiple ones at the same time. So we'll start with one that I feel is probably the most common question we got throughout, which was talking about comparing individual bonds versus bond funds or ETFs.

There's some question around defined maturity, corporate bond ETFs. So questions from Declan, and Larry, and Joni-- there's a number of folks that have posed some questions like that. So do you mind talking around individual bonds versus funds, and ETFs, and even the defined maturity ETFs?

DANIELLE FOX: Sure, so I'll save the defined maturity ETFs towards the end to do, maybe, a broader compare and contrast. So when I think about individual bonds-- and we saw it on the slide around cash flows-- the idea is, when I introduce a maturity date-based investment, assuming that I don't sell it early, and assuming the issuer does not default-- so I don't want to diminish those as potentials-- the idea is I know exactly what I'm getting, and when I'm getting it. So when I buy a municipal bond that pays semiannual interest, I know when my cash flows are occurring, to the penny and on the date that they're promised to me.

And when I have a maturity date, or a call date, I now have an exit. I don't have to go in and sell something. It's going to naturally return principal to me. So the idea around individual bonds, and why someone might prioritize that, is that they value the predictability of cash flows.

Obviously, it takes some time, some elbow grease, and capital to effectively diversify fly across issuer, and maturities, and things of that nature. So I understand it's not always for everyone. But the idea of a maturity date-based investment is, ideally, I've capped my upside and downside to my stated yield if I plan to hold it to its redemption date, and the issuer remains solvent. So it's a predictability thing.

When I think about a bond fund, it's more of a total return strategy. And what I mean by that is I accept an unknown rate of return. And what are the unknowns? The unknowns are, I might-- most bond funds will pay monthly interest. That monthly interest is variable, based on the underlying securities in the fund. In addition-- and again, this is why I'm tabling the defined maturity ETF until the end-- with most bond funds, they are perpetual. So I do not have that maturity date, where I have a defined exit in terms of date, price, et cetera.

So if I own, for example, an intermediate core bond fund, which is a pretty large Morningstar category, I perpetually own intermediate bonds until I decide to sell some or all of that capital. Now, one of the perks of a fund that you don't get with individual bonds is the ability to compound your interest automatically and reinvest. There are no partial shares, if you will, of individual bonds. They trade in increments of 1,000. So some of those things become a little bit more manual.

I would say the defined maturity ETF is really trying to marry the best of-- the greatest hits of what I described here, which is, I get the immediate diversification of a fund. When I buy a bond fund or a bond ETF, there are hundreds, if not thousands, of holdings that I had to do zero research on. So I get that immediate diversification. But with a defined maturity ETF, they have a liquidation date and an approximate liquidation price. So I've got an exit in place. It just may not be as-- the date is around a certain date, and around a certain price.

So if you're willing to accept a little variability, it's a great way to get exposure to something where you don't want to do the research yourself, but you like the idea of having an exit via maturity date. I guess those are, in the interest of making sure that we have time for other questions, probably the key attributes that I would focus on. But Matt, I guess, if you think I missed anything, I'd love to hear it.

MATT WELLS: No, I think you nailed it, Danielle. I mean, when you look at the different types, there are pros and cons in different directions. And depending on what your focus is, you can target a number of those vehicles that can help you reach your goals. So it's not that one is better than the other. But depending on what your focus is, certainly, you can lean into the attributes that most align with that.

DANIELLE FOX: Yeah. And one thing I would add is-- and you bring up a good point-- it's not an either/or scenario. I either do funds, or ETFs, or individual securities. Like, you might decide, as an example, I'm totally fine doing Treasuries because it's full faith and credit of the government, but I don't trust myself on corporates. But I like the idea of a maturity date. So maybe I do a defined maturity ETF in the corporate space, and I do Treasuries on my own. That is an example of where-- the reason that all of these types of securities and investment solutions exist is because they do all have desirable attributes, what you, as an investor, prioritize.

MATT WELLS: Perfect. So looking in the Q&A, the most liked responses, if we look at what some of our moderators have answered, particularly were talking around-- there was a question from MT around one-year CDs better than most bond types. Why buy a bond? And our moderator shared some information around tax efficiency, potentially. So can you talk a little bit more about tax efficiency, how to make that comparison, and then also, if there are any other factors that investors should look at in addition, for some of those shorter-term options?

DANIELLE FOX: Sure. So when you look at the yield chart-- and I'm going off memory here-- from top to bottom, when you're focused on a non-retirement account, and you live in a state that carries a state income tax, these are considerations that you want to think about. When I buy a CD, for example, it's going to be fully taxable at both the federal and state level. But if I buy a Treasury, and I'm in a state that assesses a state income tax, I report the income to the state government, but I don't pay tax on it.

The other thing, as you go further down the chart, corporates are going to be fully taxable. Municipals, there's a lot of funky tax rules, but ideally, it will be federally tax exempt. And ideally, if you buy your home state that assesses a state income tax, you avoid state income tax as well. The challenge is-- and I think, Matt, you would agree with this-- there are certain parts-- like in the one-year space, for short-term, there's very-- think of your own town that you live in, or city. They very rarely issue a lot of short-term debt because they're financing long-term projects-- schools, fire houses, police stations, whatever it is. And they want to pay that off over the long run.

So as you look at that chart, just because there's a yield in there doesn't mean it's a good idea per se. So it's also about focusing on where issuance practically exists. And in the CD market, lots of availability. Treasury market, lots of availability. And so then, it kind of gets into on a tax equivalent basis. And I would say, in the bond tools section that we talked about, of Fidelity.com, there is a tax equivalent yield calculator, where you can modify what yields are based on solely taxes-- not credit risk, or time horizon, or anything like that, but taxes-- to say, what are my break evens? You might find that a Treasury has a better yield than a CD if you're in a high state income tax state.

The last thing I would say, though, is, if you're worried about in case of emergency, break glass, if you're concerned about accessing that capital within that year maturity-- I think, was the example MT had given us-- I might prioritize a Treasury. Because nothing is as liquid or as actively traded as the Treasury market. It's not that CDs are illiquid, but you're looking at the Treasury market kind of being your gold standard of liquidity. So if the prematurity liquidity piece is an important attribute that you want to factor into your decision-- pardon me-- you might want to prioritize a Treasury.

So I would say, for shorter-term securities, CDs and Treasuries tend to be where the supply practically exists. It gets a little more challenging in corporates and municipals. The last thing I'll say around corporates is, you never want to let time create complacency around credit risk. If Sears goes bankrupt, whether you owned a six-month security or a six-year security, you got caught up in it all the same. So don't let that function of time create any complacency around, well, how much can go wrong in six months? A lot.

MATT WELLS: Absolutely. Well, thank you. Yeah, so looking through the Q&A, I see a question from Williams, pointing out, the problem with ETF or mutual funds is when the bond market crashes, like in 2022. So, we know we have a scenario where, of course, any investment that you make is not risk-free. There are certain risks associated with it. So some clients are looking to navigate the interest rate risk in particular, like we saw in 2022, where positions did lose value, and funds did lose value. Can you share some of the things that clients can do to help protect them versus some of that interest rate risk?

DANIELLE FOX: Sure. I would say, this is where introducing a maturity date helps, but it doesn't solve everything. And what I mean by that is when you have a maturity date, gains and losses have to go to zero when a bond comes due, assuming that the issuer is still solvent, and you haven't sold it early, and all that fun stuff, versus that perpetuity of a fund. And again, I'm keeping defined maturity ETFs out of the equation just to do a broader base compare and contrast. But if I own an individual bond with a maturity date, it doesn't mean it didn't go down in value while I was waiting for it to come due.

So oftentimes, when you have these exogenous shocks, or something like COVID, or Liberation Day-- name the event, right-- an individual security, a CD, a Treasury, whatever it is, it can lose value. The difference is, can you see the forest through the trees? And what I mean by that is, can you see through to the maturity date? So oftentimes, Williams, we're asked to show patients at the hardest possible time, which is when yields are rising, or there's risk in the market, and bond prices are falling.

If I have an individual security, I have an end date, and I have an exit strategy. But I have to be able to see my way through it. And everyone's buy and hold until they're not. So I think we sometimes-- you just want to reflect, yourself, around, can I actually hold on when I'm asked to show that kind of patience?

MATT WELLS: And one way to gauge that, Danielle, is, certainly, if you have a fund or an ETF that has an extended track record, you can look back to see how it did in certain times, so to see a stress test by looking backwards. Now, of course, we know past performance doesn't equal future results. And different market conditions are changing constantly. However, if you look back and see what it did at certain times, that could be a helpful guideline for you to understand what risks are associated with the different options that you have.

DANIELLE FOX: Totally. And to that end, just to add to it, it's like, all right, I might have, as an example, lost 8% in a year on something. And how long did it take me to get it back? And is that, potentially, a time horizon that I am willing to accept with my safer money? And for some, that's OK, and for some, it's not. And that's where, if that concept maybe is testing your mettle a little too much, then it's going higher quality and maturity date-based investments that you feel comfortable maintaining over time.

MATT WELLS: Perfect. I think we have time for one last question, and it'll be a fun one. I've seen a few questions throughout the Q&A, and also, one just recently came in from Natan, around looking at TIPS. So how do we tackle some of the inflation risk? You pointed out the market environment, inflation is a little bit elevated right now. How can investors tackle the inflation risk that they can see with bonds? And what are some of the different options to do that?

DANIELLE FOX: Yeah, so the TIPS market, within the Treasury market, it's a smaller part of the market, maybe a trillion or so of our debt, which still a lot of money. I get it. But you definitely want to do your research in understanding the mechanics of how they work. There's no way to quickly and easily explain them. But in essence, you are buying something at-- like right now, they're in the 2% range. Let's call it a little over 2%. And what you're saying is, regardless of what inflation is, let's say I get 2% over the real yield. So they're quoted on a real yield basis, not a nominal yield basis, which is a fancy way of saying, I'm locking in a yield over inflation as measured by the CPI.

There's, I would say, structural considerations around how they pay interest that you might care about in terms of the inflation factor and understanding how that works, and then, tax issues. So you may think location-wise of where you want to hold them. They are subject to phantom income tax when you buy them individually, outside of an IRA. There are ETFs and mutual funds that will buy them as well to help solve for that.

But I guess, the other thing is also thinking about, in the bigger picture, long-term asset allocation. Hopefully, folks believe, over the long run, that the equity market is probably your best inflation hedge in terms of growing your wealth. So when you think about how TIPS might fit in, it's about protecting your bond portfolio from erosion via inflation, as opposed to, I own equities and growth-oriented assets, and I'm going to buy TIPS to protect.

So I understand 2022 is still kind of fresh in everyone's head. But when you look at the long run, your asset allocation, it's about having enough dollars outpacing inflation, not necessarily all dollars. So everyone's going to make a different determination around TIPS. But you always want to be thoughtful around them in terms of a satellite allocation to protect your bond portfolio, not necessarily your equity portfolio, and then, if you're going to do them individually, thinking through the tax piece and whether or not you want to locate them in a retirement account. That's the quick and dirty on it, I guess.

MATT WELLS: Perfect. Well, we'll leave it there. I appreciate the question. And actually, one last thing to add on that front. To your point about asset allocation, it's important to have an overall plan that matches your risk tolerance, time horizon. And Fidelity can help you develop that overall plan. And to the extent that bonds are part of that plan, we have plenty of resources to support you. If you enjoyed today's session and would like to join another webinar or coaching session, please visit Fidelity.com/webinars.

So Danielle, thank you so much for joining us and sharing your knowledge with the audience. And thank you all for joining. We hope to see you again soon.

DANIELLE FOX: Thanks, Matt, for helping host.

MATT WELLS: My pleasure.