Is fixed income an asset class on life support?
As we expected, with the rollout of the COVID-19 vaccine and the huge levels of ongoing support from governments and central banks, the global economy has continued to heal, and investors have moved away from defensive assets.
At the time of writing, the more upbeat global economic outlook has led to rising concerns about inflation. As a result, we have witnessed a sell-off in bond markets and a significant jump in bond yields at a rate we have not seen for some years. The Australian Broad Bond Index (Bloomberg AusBond Composite Bond 0+ Index) posted its worst monthly return on record for the month of February 2021 as Australian 10-year government bonds sold off almost 0.80%. Global bond markets also suffered heavy losses.
Can fixed income still be a key defensive player in your clients' portfolios?
Before the recent sell-off, fixed income had been on a 30-year bull run and acted as a cushion in diversified portfolios. During 2020, it offered protection from the heavy blows dealt to growth assets through the COVID-19 impacts on financial markets. But what now?
Before putting fixed income on the ‘do not resuscitate’ list, let’s unpack the role it can continue to play in portfolios and explain the strategies that can help to maximise value in this increasingly complex and evolving asset class.
Opportunities still exist, but the game has changed
For most advisers, fixed income is a ‘must have’ of an asset allocation construct but many would question the focus, with most benchmarks showing less than a 1% yield.
IOOF’s Head of Fixed Interest Assets, Osvaldo Acosta, stated “with the right strategies at play, it’s still possible to construct a fixed income portfolio that delivers income, protects capital and yields up to 3%.”
Unpicking this further, it is clear that a new approach is needed with changing economic cycles. The bull run appears to have ended, so the passive ‘beta’ approach that has worked in the past may now be a risky approach. As Osvaldo explains, “the traditional ‘cookie cutter’ approach to fixed income isn’t going to deliver anymore. The evolution in fixed income means that more attention is required.”
Getting active at many levels
Mark Nordio, IOOF’s Senior Manager Fixed Asset and Strategy, puts it plainly, “this is a really bad environment for a passive approach to fixed income.” Unlike equities, where you may focus on a ‘style’ bias, there are many different specialist levers to pull to get the most from this asset class, across the distinct layers of a fixed income portfolio construction. Let’s explore this further.
Fixed income is an inherently diverse asset class with strategies that could include high quality credit, floating rate, relative value, low duration, emerging market, high yield or private debt. So, at the very base level, identifying the right strategy blend is key. As the recent upheaval in bond markets has proven, the right blend can make or break your strategy.
Once the appropriate strategy blend is in place, identifying the quality ‘best of breed’ managers for the mix is crucial. Within a multi-manager approach, managers must complement each other and be able to deliver on each different strategy so there is an appropriate mix to offer ‘true’ diversification. As an example, there are managers that can deliver on macro, some on credit and then others that have a low correlation to macro and credit and use other return drivers.
By having a team of specialist fixed income portfolio managers, mandates can be customised. Those in the market who have scale can demand strategies that may not be available to a retail investor in many instances. This could mean deciding on things like exposure levels to China and managing how that overlays with an exposure to Emerging Market debt, for example.
Time to resuscitate
The recent pain in fixed income markets presents some great opportunities and the current sell-off means that it’s likely to be at good valuation levels. That said, it’s an asset class that can be a challenge to navigate successfully and specialist expertise can make all the difference.
If you’d like more information, please speak to your IOOF Client Solutions Manager.