Senior Portfolio Strategist Damien Comeaux explains how bond investors may be able to take advantage of fixed income markets’ inefficiencies.

Key Takeaways

  • Fixed income markets are far from efficient, and that is good news for investors struggling to find balance between risk management and income.
  • Given the rate environment globally, investors may need to dig deeper into the defensive tool kit to uncover new opportunities and trade-offs within core fixed income investments.

Even in the face of today’s low-rate environment, core fixed income’s role is as essential as ever: helping provide capital preservation during a crisis. However, with most global sovereign bond rates below 1% or negative, traditional benchmarks with large passive weightings to sovereign debt are no longer a bond investor’s North Star.

Still, abandoning core fixed income because of low U.S. Treasury yields is throwing the baby out with the bathwater. Instead, forward-looking investors will need to pursue a new level of due diligence for each destination of capital within their core fixed income allocation. Fixed income markets are far from efficient, and that is good news for investors grappling to find balance between the needs of risk management and portfolio income.

Fixed Income's Inefficient Frontier

Source: Bloomberg, as of 31 December 2020. Note: Yield cushion defined as Yield to Worst (YTW) divided by duration.

 

Instead of abandoning core fixed income, investors must dig deeper into the defensive tool kit to understand new opportunities and trade-offs within core fixed income investments. The above chart illustrates the duration and yield of core fixed income asset classes and helps to demonstrate the primary trade-off investors are facing today. Treasuries are just the beginning of the core fixed income universe. Investments such as short-term credit, mortgage-backed securities (MBS) and high-quality collateralized loan obligations (CLOs) may result in a higher yield without adding additional interest rate risk while still providing the necessary risk management to the broader portfolio.

There are no easy choices – only trade-offs. We believe clients are best served by taking a multifaceted, goals-based approach to pursue scarce income while carefully balancing risk.

To learn more, read the Portfolio Construction and Strategy Team’s 2021 outlook: Recover Wisely: Be Global, Be Picky.