A Not So Passive Way of Looking at Fixed Income InvestingSubmitted by GRP Advisor Alliance on August 21st, 2018
The landscape of fixed income investments is changing, and investors may want to reconsider how they are thinking about risk and opportunity within their debt portfolio. The quantitative easing program undertaken by the Fed in response to the 2008 Global Financial Crisis is coming to an end. In June of this year the Fed raised interest rates for the seventh time since December 2015 and indications are that two more rate hikes will occur in 2018.
According to the 2018 Natixis Global Survey of Institutional Investors, interest rates rank as the top portfolio risk for institutions. In fact, those institutional investors see rising rates as a bigger portfolio risk than asset price volatility. Furthermore, six in ten institutions believe interest rate increases will have a negative impact on portfolio performance in the year ahead. Seven in ten also believe bond volatility will increase over the next year.
While fixed income strategies remain a core component of investors’ asset allocations as a source of income and portfolio diversification, it’s important to be prepared for the a potentially volatile future. While actively managed bond strategies still hold a majority of the investor market, passive bond strategies have been gaining market share quickly.
But how might heightened volatility affect the returns of passive strategies and how do indexed portfolios mitigate risk? According to T. Rowe Price’s 2017 Price Perspective Analysis® Report actively managed bond strategies possess inherent advantages that can help mitigate downside risk and enhance returns that passive strategies do not consider.
During a rising rate environment, it is often supposed that active managers can shorten a portfolio’s duration, thus mitigating the risk of rising interest rates. In theory, active managers can also access multiple fixed income sectors, such as TIPS or High Yield Bonds that do not meet aggregate index eligibility requirements. These strategies employed by active portfolio managers can help further diversify a portfolio and seek attractive returns while minimizing downside risk.
What should investors consider in this changing landscape?
Active bond strategies might help. Especially funds that emphasize fundamental credit research to mitigate downside risk and enhance returns—especially if market volatility increases as global central banks withdraw support and the credit cycle enters its late stages.
With the potential for rising interest rates and increased turbulence in richly valued credit markets, prudent security selection and interest rate management will likely become even more important drivers of performance.
As always, it’s imperitve for instituional investors to review the asset allocation and investment stragegies of their portfolios and to make adjustments based on risk tollerance and market outlook. The requisite for vigilience is especially prevelant in volitile market environments.
How might investors and plan participants take action?
If what was described concerns your financial future, contact your financial advisor to explore alternatives. When selecting an actively managed fixed income fund one should consider a fund that maximizes total return through a well-diversified fixed income strategy that includes limited exposure to opportunistic debt sectors while using a time tested, value-oriented investment process led by a deep and experienced team of credit specialists.