As yields bounce back, fixed income is doing its traditional job again and making a case for rebalancing.GETTY IMAGES
Fixed income is re-emerging as a core portfolio driver after years of ultra-low yields that pushed many investors to take higher risks.
Government debt yielded little and cash paid virtually nothing. Now “we’ve gotten back to a normalized interest-rate environment,” says Marty Balch, senior portfolio manager for RBC Global Asset Management’s fixed income and currency team in Toronto.
Government bonds yielding 3 per cent to 4 per cent are once again capable of forming the foundation of a portfolio. Investors can earn returns above inflation, generate dependable cash flow, and reintroduce ballast into allocations that had become increasingly equity-heavy or reliant on structured and alternative products.
“Today, you’re sitting in a place where fixed income has regained its rightful purpose,” says Aaron Young, executive director and head of client portfolio management at CIBC Asset Management in Toronto.
The modern fixed-income toolkit is far broader and more sophisticated than in the past. Investors seeking stability and diversification can find new opportunities in both bonds and private credit.
Higher starting yields provide more flexibility, Mr. Young says. He adds that he believes investors should increasingly think about the market as “range bound,” rather than expecting either a return to near-zero rates or another aggressive tightening cycle.
That backdrop is reshaping how fixed income is constructed inside portfolios. Rather than simply chasing headline yield, managers are becoming more selective about where income is coming from and what risks investors are actually taking.
“When yields were ultra-low, you got forced out the risk spectrum,” Mr. Balch says.
Many managers are now moving toward higher-quality credit. Investment-grade corporate bonds remain attractive, particularly at the front end of the yield curve where investors can generate incremental spread income without taking excessive duration risk.
But credit spreads – the basis-point difference between a bond’s interest rate and a sovereign yield curve rate (typically U.S. Treasuries) – remain historically tight. “There’s way more room for spreads to widen than to tighten from here,” Mr. Balch says.
The higher quality-oriented approach extends beyond corporate credit into structured products higher up the capital structure, Mr. Young says, such as collateralized loan obligations (CLOs) and other private credit options.
Many investors have increasingly embraced private loans and structured credit products that promise higher returns and lower correlation to traditional markets. The appeal is understandable, provided investors understand the trade-off, including less liquidity. “So you should get paid for that,” Mr. Balch says.
He and Mr. Young do not view private credit as fundamentally separate from traditional credit markets. “There’s a bit of demystifying to be done around private credit strategies,” Mr. Young says. “One of my first bosses always told me, ‘Credit is credit is credit.’”
He says he believes the more compelling opportunity may ultimately lie in combining long-term private credit exposure with actively managed public credit strategies that are capable of capitalizing on periodic market dislocations. “When we see selloffs in public corporate bonds, that’s where you can get really outsized returns,” he explains.
Structured credit products such as CLOs – particularly higher-quality AAA and AA tranches – continue to attract institutional demand. Mr. Young says the appeal lies in the balance between income generation and structural downside protection, given their high ranking in borrowers’ capital structures.
“We think the higher-quality segment of CLOs is an interesting opportunity where you get both an underlying element of risk mitigation and a structural element,” he says.
Accessibility is also expanding rapidly through ETF wrappers and mutual funds, bringing institutional-style credit strategies to a broader wealth audience.
Following a period when investors questioned whether government and corporate credit still served a purpose at all, fixed income is once again doing what it was designed for: generate income, provide diversification, and help investors navigate uncertainty.
“Fixed income has had to re-earn the respect in the total portfolio context, but it’s been able to do so,” Mr. Young says.