Historically low levels of yield for fixed income may be disillusioning some investors. Those that aren’t being actively managed do run the risk of incurring capital losses, but the duration exposure offered by fixed income is the best way to cushion portfolio losses during equity market downturns, says Altius chief investment officer Bill Bovingdon.
He says the best way clients can make the most of fixed income is by ensuring portfolios are actively managed, and there are a few strategies clients can implement.
“There is a tendency for investors to lump all fixed income funds into the one bucket, yet active managers that have developed processes and strategies – such as the ability to switch into credit strategies and floating rate notes – can add real value,” says Bovingdon.
In a rising rate environment, Bovingdon recommends short-dated bonds, which have a lower duration and are therefore less sensitive to interest rate charges.
“Short-dated corporate bonds that have a yield above the cash rate benefit from capital gains (in addition to accrued income) as the yield falls toward the cash rate over the life of the security.
“Other strategies include investing in floating rate notes (FRNs), as they pay a fixed margin above an agreed level such as the bank bill swap rate and avoid the downside of rising interest rates by giving up some of the potential upside if rates fall. In a rising interest rate environment, spread compression can lead to capital gains in FRNs. Using interest rate swaps to swap fixed rates for floating rates can also benefit returns.”
While duration is your friend in poor economic environments, Bovingdon says it can quickly turn into a foe when the economy improves if the bond investments are not well-managed, and traditionally managed fixed income portfolios do not provide the flexibility that is needed for clients to do well.