With the benefit of hindsight, there have been few investments as attractive as core U.S. fixed income over the last 30 years. Capital preservation, income, diversification, and even hedging volatility: was there anything fixed income did not provide?
With 10-year U.S. Treasury rates nearing all-time lows, however, the cost/benefit math may be less in favor of this once heroic asset class. Our fear is not necessarily rising rates, rate volatility, or even the risk of a spike in inflation. Rather, quite simply, low present rates imply low forward returns, making large allocations to traditional fixed income a potentially costly choice.
Living in the unprecedented era of globalized, experimental central bank policy, we believe reexamining the size and role of fixed income within our portfolios is warranted. Given all that core fixed income has been able to achieve for investors historically, is there a way to go about replacing this exposure while simultaneously reducing our exposure to interest rates?
At Newfound, we believe the answer is to unbundle and rebuild: unbundle the objectives, solve for them individually, and rebuild a solution from the sleeves.
The first step of the process is to build a solution for each of the four objectives.
We believe that short-term fixed income is still one of the best ways to preserve capital. Positions in ETFs such as GSY and MINT, which focus on finding enhanced yield opportunities in the short duration space, may help an investor achieve the necessary safety while at least dampening the impact of inflation.
To satisfy income needs in today’s interest rate environment, we believe that investors should look towards extended fixed income sectors like high yield bonds (JNK and HYS), bank loans (SRLN), emerging market debt (EBND), and high yield municipals (HYMB). While each of these sectors comes with its own significant idiosyncratic risk, we believe an actively managed and thoughtfully diversified portfolio of such exposures can help mitigate these risks.
The continued proliferation of exchange traded funds means that many diversifying, alternative strategies that were once only available in hedge fund structures are now available to all investors. The benefit of many of these approaches is that they can offer diversification to both traditional equities and fixed income.