Are fixed income myths driving your decisions?

Fixed income can play an important role in diversifying a portfolio, but several myths may be keeping you from taking action.

Dec 17, 2012 | New and Noteworthy Archive

Meg McClellan

Head of U.S. Fixed Income

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Fixed income can play an important role in diversifying a portfolio, allowing it to better withstand continued volatile and uncertain markets. But several myths may be keeping you from taking action. Let’s take a closer look at the reality that should inform your decisions.

Myth #1 There’s a bond bubble
One myth is the belief that fixed income is a bubble waiting to burst, given the hundreds of billions of dollars that have moved into the asset class over the past two or three years. However, despite these healthy flows, global portfolio weightings to fixed income appear to be no larger than their historical averages of around 30%. In our view, this doesn’t point to an over-allocation to the asset class. Where we do see out-of-the-norm investment exposures are in today’s high allocations to cash and low allocations to equities.

Myth #2 It’s too late to invest in extended credit
Another misconception concerns extended credit. To diversify away from municipal or developed markets government bonds, investors often look to extended credit markets, typically higher-quality, fixed rate, high yield bonds. Over the last few years, these investments have earned equity-like returns with bond-like volatility, especially in 2012. This has increased their popularity, giving rise to fears that all extended credit is now too expensive. While we remain watchful in case high yield bonds move closer to being fully priced, it’s important to remember that extended credit expands beyond these investments. It covers a variety of fixed and floating rate vehicles, including bank loans or leveraged loans, residential mortgage-backed securities (RMBS), and commercial mortgage-backed securities (CMBS). We still see a great many investment opportunities here.

Myth #3 Inflation will always be low, so I don’t need insurance against it rising

This falls under the category of “what’s happening right now is the way it will be forever.” Rising inflation and higher interest rates may seem like a distant prospect—especially if you’ve only ever invested in fixed income during a bull market, where you see the value of your bond portfolio increase and interest rates fall. However, while we have experienced a benign inflation environment for several decades, this will not last indefinitely. Loose monetary policy and expansion of the money supply are two known potential catalysts for future inflation. When you think about the negative impact that a rise in interest rates can have on long-term bond investments, adding some diversification to your bond portfolio as a counterbalance is a prudent move. We like to achieve this diversification through inflation protection, either by way of floating rate assets, which typically rise with interest rates, or through assets that are directly linked to inflation. Both of these should prove to be extremely cheap long-term insurance against inflation when interest rates ultimately return to more normal levels.

Myth #4 We’re living in unique, unprecedented times

While history never repeats itself exactly, we have seen conditions like this before. We have lived through deleveraging cycles where corporations and individuals have focused on paying down their debt. It is true that interest rates are at near record lows, but coupled with low growth, this may prove to be positive for corporate credit as people search harder for yield. While rumors and misconceptions tend to multiply in uncertain markets, what could really jeopardize your long-term wealth strategies is not considering different ways to diversify your portfolio, including fixed income. In our view, incorporating fixed income can allow you to take advantage of a diverse range of opportunities, help mitigate the effects of volatile markets, and keep your portfolio well positioned for changing market conditions—now and over the longer term.