The 'income' is back: Fixed income returning to favour with money managers
Higher yields "allow bonds to play that traditional role of portfolio ballast," one expert says
After a tumultuous 2022 that ravaged the bond market, fixed income investments are starting to come back in favour with fund managers as yields climb to levels not seen in more than a decade.
"In short, 'income' is back in fixed income," Rachel Siu, head of Canadian fixed income strategy at BlackRock, told Yahoo Finance Canada.
"Investors can now achieve compelling yields of 4-5% staying in high-quality exposures and no longer need to 'reach for yield' in riskier parts of the market such as high yield to accomplish their income objectives."
While fixed income yields are at "attractive levels," the bond market isn't out of the woods just yet, according to Earl Davis, the head of fixed income and money markets at BMO Global Asset Management.
We're seeing increased interest at these levels from institutional investors because they realize the value proposition.Earl Davis, head of fixed income, BMO
Davis says there are a number of risks including how the economy unfolds and the possibility of a recession, concerns about U.S. regional banks after the collapse of several lenders, and whether there could be a resurgence of inflation.
Despite those uncertainties, institutional money is flowing back into the fixed income space, he says.
"We're seeing increased interest at these levels from institutional investors because they realize the value proposition. We expect retail investors to be showing up at the end of this year and into 2024," he said.
Short-term pain, long-term gain
Investors were left reeling after the rapid rise in interest rates led to a sharp repricing of asset classes, including the bond market, which is typically known for being a safe place to stash money during volatility.
Davis says the old saying 'short-term pain for long-term gain' comes to mind when he thinks about how the fixed income market has evolved over the past year.
Fixed income portfolios declined about 10 per cent last year because of the rapidly changing rate environment, but higher rates also mean expectations for fixed income returns in the long term are now "significantly higher" than they were at the beginning of 2022, he says.
Meanwhile, Siu says bonds can resume their rightful role in portfolio construction.
"These higher yield levels offer greater income cushion and allow bonds to play that traditional role of portfolio ballast," she said.
Getting the right fixed income exposure
Siu says bond exchange-traded funds (ETFs) are a simple and liquid way to get exposure to fixed income compared to buying individual bonds over the counter.
She says funds such as a long-duration U.S. Treasury-based ETF (XTLH.TO) or the Canadian universe bond ETF (XBB.TO) can offer diversification and protection in times of volatile trading.
Meanwhile, Davis prefers short-term bond durations because of the lingering uncertainty over whether the Bank of Canada will hike its benchmark rate one more time this summer to "put the nail in the coffin of inflation."
Until there's more clarity, he suggests sticking with short-term corporate bond funds, which invest in company debt with two- to five-year maturities.
Michelle Zadikian is a senior reporter at Yahoo Finance Canada. Follow her on Twitter @m_zadikian.
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