In Defense of Defensive Fixed Income: The Case for Adding Duration
This year, the motto for fixed income investors is “pain to gain” – historical losses in traditional fixed income benchmarks (pain) have given way to an environment where investment grade, core fixed income is offering yields in the mid-single digits (gain). The challenge for fixed income investors is how to best access the silver lining that comes with this year’s volatility.
Fixed income’s precipitous decline alongside the downturn in equities has left investors with existential questions surrounding their bond portfolios. Many are wondering what, if any, benefit bonds can provide in portfolios going forward.
Throughout our client consultations this year, we have found that it’s difficult for most investors to avoid dwelling on the year-to-date trauma. Some have been hiding out on the short end of the yield curve, which has been more insulated from the extreme interest rate volatility. In our view, however, today’s rapidly shifting environment means investors should shift their focus to the fresh opportunity set these historic losses have left in their wake.
While questions remain on the path forward for inflation, we would encourage investors to embrace intermediate bonds again, and to look to extend duration for the following three reasons.
For years, central banks have kept interest rates artificially low, minimizing the income one could get from a fixed income portfolio. One benefit of the repricing we’ve seen with bond valuations is that investors can now realize more attractive yields from core fixed income.
If no further hawkishness from the Fed is required and rates remain consistent where they’re currently priced, longer duration fixed income can reliably provide coupons at more compelling levels than were afforded in the past.
While the yield curve inversion during 2022 means that short duration is providing similar levels of income as intermediate duration, it is the additional duration “risk” in the intermediate space that proves most attractive if we indeed enter a risk-off recessionary environment.