Fixed Income: Low Yields Don’t Tell the Whole Story

It’s tempting these days for some investors to question the role of fixed income in portfolios. After all, real yields have plunged, potentially leading to less income today and smaller capital gains tomorrow.

But yields are far from the full story. Despite low yields, bonds can continue to diversify risk in broad portfolios. Interest rates may fall further, boosting valuations. And some segments of the fixed income market – credit in particular – remain attractive relative to equities, in our view.

We believe active management remains the key to realizing this potential, as our research indicates that active management is more adept in fixed income than in equities. For a deep dive into our views, read our Research paper, “The Discreet Charm of Fixed Income.” Here are the key takeaways:

Bonds can continue to serve as a potent diversifier in broad portfolios

Although the stock-bond correlation has been weak in recent decades, fixed income returns have been positive in nearly all recessions since 1952, even in periods when stock-bond correlations were positive. In fact, the relationship between these two asset classes depends critically on the level of market valuation, as we wrote last year in “Stocks, Bonds, and Causality,” in the Journal of Portfolio Management.