Recently, many market commentators have been preaching the message that fixed income investors should stick to a low duration strategy. It is important to frame any investment advice in order to properly interpret the reasoning and thinking behind it before deciding whether or not it applies to a specific investor’s goals and needs, especially yours! Many of the speakers on the TV and/or conference circuit are on the active management side of the business. This means that they view the world through the lens of managing a packaged product where success or failure is determined by whether they outperformed or underperformed relative to some benchmark. Simply put, their investment decisions are based on what they think the price movement of their investments is/could be on a quarterly or annual basis. The current bias of many voices out there to stay short is intended to mitigate any near-term downward price moves in the event rates continue to rise. There is much more downside price risk in longer maturity bonds than short maturities while at the same time there are attractive yields to be found in very short maturity bonds, so why not just stay short?
This line of thinking has some merit if you are measuring your performance in the way that active managers do, but this might not be the best advice for buy-and-hold investors who invest in individual bonds instead of a packaged product. When you allocate to fixed income via a portfolio of individual bonds, you are designing a portfolio intended to accomplish your long-term goals, not to beat some arbitrary benchmark. When you buy an individual bond and hold until maturity, interim price movement does not affect your total return. Barring a default, the yield, cash flow, and maturity value are all known upfront and do not change, regardless of any interest rate or price changes that occur during your holding period. Given the known aspects that come with owning bonds, you can map out your future with a portfolio of bonds in a way that you can’t with a packaged product.
Currently, the market is providing yields at levels not seen in 10 to 15 years in some parts of the market. Given the current shape of the Treasury curve (deeply inverted) and the potential for a coming recession, there is a high probability that the FOMC’s tightening cycle is near its end. If history is any indicator, this means that longer term yields will begin trending lower in the not-too-distant future. For investors with a time horizon past the next few years, like those investors who are in or near retirement, locking in currently available yields for a longer period of time may make sense. These yields might not be around much longer. While unique market dynamics have provided the current opportunity, there are many structural tailwinds for lower rates going forwards such as demographic trends (retiring Baby Boomer generation and their investment needs), falling inflation, high levels of sovereign debt, and global interest rate disparity to name a few. While we don’t have a crystal ball, the yields that are currently available on the intermediate and long part of the curve could very well be a once-in-a-generation opportunity.