It's Time to Throw out the Old Bond-Investing Playbook

Boston - Recent posts from the diversified fixed income team have discussed how bond investors should be prepared to navigate a market that may look very different from what they've grown used to. In other words, it might be time to reassess the old bond-investing playbook.

The markets are in the throes of transition -- in fact, several transitions. These shifts will occur over various periods of time: short term, medium to long term, and long term.

Here, we'll introduce some of these important shifts. Future posts will delve deeper into specific themes that point to a new regime in the bond market, and why investors may not have to view a secular rise in interest rates as the ultimate headwind for fixed income.

Indeed, there are many challenges facing fixed-income investors now. But two of the most important include how to plot a course through rising interest rates, and how shifting correlations may change the role of bonds in an overall portfolio allocation. I believe it's safe to say that many portfolio managers haven't faced the type of environment we may be moving into.

Handoff from monetary to fiscal policy

The transition from monetary policy to fiscal policy falls in our "short-term" bucket of important bond market transitions.

The immediate challenge for investors is to understand that global central banks are now ending the period of monetary stimulus. The Federal Reserve and other central banks want to get back to normal after a decade of supporting markets and economies with quantitative easing (QE).

This means rate hikes and shrinking central bank balance sheets. In this complacent landscape, it is difficult to imagine why rate moves higher would be anything other than gradual. Except that valuations in the bond markets are stretched. Therefore, the old playbook of reaching for yield by lengthening duration and going down in credit quality may not work as well as in the past.