Navigating Risks & Rewards in Fixed Income Strategies

With the Fed’s agenda underway, investors are trying to figure out how to best position their fixed income portfolio for long-term results. With speculation high over how many rate cuts to expect, when do the rewards outweigh the risks?

For Brian Ellis, CFA, managing director at Morgan Stanley Investment Management, it’s important to consider the direction that the Fed’s rate regime is moving, rather than the amount of cuts themselves. He recently participated in the VettaFi Q4 Fixed Income Symposium

According to him, ongoing normalization in both inflation and the labor market should contribute to an easing cycle. He reiterated his belief that the Fed has enough leeway to make a few more rate cuts through the rest of the year. 

Looking into 2025, he remained less certain. Much of next year’s fiscal policy may be determined by the results of the upcoming presidential election in November. That being said, he believed that rates across the curve are reasonably priced at the time 

“We are positioned for a steeper yield curve,” he said. “That was one of our highest convictions in the last year. It continues to be one of our more strong convictions going into the next year.”

Duration and Quality

In terms of duration, he favored the one-to-five-year section of the curve, compared to the longer end. He maintained that the lower duration can outperform in a variety of markets. 

Throughout the year, he observed how investors have reallocated toward high-quality fixed income investments. In particular, he highlighted investment-grade corporates as being in “the epicenter of that.”

According to him, this trend should be expected to continue. While the trend was originally mostly favored by institutional investors, retail traders are now moving toward high-quality. 

“Investment-grade corporates are a very large, liquid market, and that’s probably why you’ve seen spreads compressed the way that they are,” he noted. 

Even though investor enthusiasm has been strong, he advised investors to be wary of risks. Fixed income strategies still contain plenty of risk, even during a soft landing. 

“The one caution that we’re trying to really focus on is that soft landings are bumpy. They do not mean that there are really no risks,” he added.

Underappreciated Opportunity

Looking at fixed income strategies, he saw an opportunity in securitized credit. He appreciated how securitized credit can amplify portfolio quality and maintain a positive position on the yield curve. 

Paul Norris, vice president and senior portfolio manager at American Century Investments, also participated in the panel. Among securitized credit options, Norris highlighted that Agency MBS and AAA mortgages present good investment opportunities. 

“As we enter through the election, and then outside the other side of the election, it’s going to be bumpy,” he noted. “We think agency mortgages are a really great defensive instrument that will outperform during these bumpy periods.” 

Options From Eaton Vance

“We’re trying to focus on what do we realize, in terms of upside, if that solid landing does play out. I think what we conclude is that it’s really not an environment where we should expect broad spreads tightening across many sectors. You really should be emphasizing more carry and more income to portfolios,” Ellis said. 

Even though cash instruments have done well over the past few years, those returns will be cut down in an easing cycle. He explained that fixed income ETFs that move out of the yield curve can significantly outperform cash.

In particular, he noted that many investors are opting to pivot to the Eaton Vance Total Return Bond ETF (EVTR). The fund works as a core fixed income portfolio with a duration between three and five years. 

However, he said that some investors are not seeking to take on much duration risk. As such, the Eaton Vance Short Duration Income ETF (EVSD) may be an attractive investment option. 

EVSD offers a lower average portfolio maturity, with many assets sitting between zero and three years in duration. This can be a beneficial strategy for investors who do not wish to step out too far on the yield curve. 

For more news, information, and analysis visit The ETF Yield Channel.