There’s plenty of talk about the trying fixed income climate advisors and investors are facing this year, but broadly speaking, catastrophe is being averted, and some corners of the bond market are proving surprisingly resilient.
Still, investors are apt to be concerned about the effects inflation, transitory as it may prove to be, will have on bonds and whether or not the Federal Reserve will proceed with raising interest rates sooner than expected. Only time will tell what the outcomes of these scenarios will be, but an ounce of prevention is often worth a pound of cure.
One way of preparing for the worst is to go low with duration while seeking credit opportunities to buffer against today’s still anemic government and municipal bond yields.
“Low-duration assets are a way to protect against capital losses in a rising rate environment, as they are quicker to benefit,” said Mark Hackett, Nationwide chief investment officer, research, in a recent note. “This group has been dismissed by many investors due to the low level of absolute yields and the strong relative returns in longer-duration assets.”
With 10-year Treasury yields still low and default risk declining, corporate bonds could be a prime destination for investors seeking to tap into credit opportunities while bolstering income. The case for that asset class is bolstered by the improving economy and the need to boost income in inflationary environments.
“Meanwhile, exposure to credit-sensitive assets could mitigate the low-yield environment, as the improving economy, accelerating earnings and higher commodity costs act as a tailwind,” added Hackett.
One thing is clear: advisors and investors shouldn’t get into the business of predicting when the Federal Reserve will increase borrowing costs.
“Since the financial crisis, the consensus of economists was high in their estimate for the 10-year yield 10 of 11 times, with the last two years being among the worst. The bias is almost exclusively to the upside, assuming a reversion to the mean,” adds Hackett.
Of course, rates have been trending lower over that period and now reside at historic lows. Investors would do well to focus things they can control, including credit and duration risk, and leave the guessing games to other market participants.
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