For years now, fixed-income investors have had to navigate a daunting environment characterized by historically low (and even negative) interest rates or yields. As a result, many have had to rethink how they traditionally approach fixed-income investing. In this post, we investigate the current low-yield environment of the fixed-income market and discuss contemporary means to make head or tail out of it.
Understanding the Low-Yield Environment
These conditions are due to a few things that have given us this low-yield world:
Central bank actions: In a bid to kickstart growth, many central banks have kept interest rates low in the face of economic headwinds.
Economic uncertainty around the world: Geopolitical tensions and faltering economies are forcing investors to turn toward government bonds, depressing yields.
Aging populations in developed countries have shifted investor preferences towards bonds and we are witnessing some of the results now as bond yields decline.
These factors have given rise to a “new normal” where traditional fixed-income strategies will likely fall short of the returns investors require to achieve their financial return objectives.
Challenges for Fixed Income Investors
The low-yield environment brings several challenges for fixed-income investors:
Lower-income generation: With lower yields, it is more difficult to generate enough interest payments needed for the reduction in payouts.
Higher-interest rate risk: When yields are low, prices of fixed-income securities can fall sharply with even small hikes in interest rates.
Inflation risk — with yields in many cases below inflation rates, fixed-income investments might lose their purchasing power over time.
In this climate, investors must reconsider fixed-income investing.
Innovative Strategies for a Low-Yield World
1. Diversifying Globally
Another approach to boost yields is not lending in the domestic market alone For example, bonds from emerging market debt can provide yields that are greater than developed market bonds. However, these types of investments add a further layer of risk, including that related to currency movements and political instability; at the same time, they can also significantly enhance diversification properties and potentially return more than standard asset classes.
2. Exploring Alternative Fixed Income
FOR INVESTOR USE: Fixed income investments may be subject to risks including, but not limited to, interest rate changes with the potential for a decline in value.
Private debt — Higher yielding solution via direct lending to companies (potentially higher yields than corporate bonds)
Infrastructure debt—Financing: infrastructure projects provide stable and long-dated cash flows
*Real estate debt — CMBS, RMBS (Commercial mortgage-backed securities and Residential mortgage-backed securities for example) can provide high-yielding alternatives.
While they may have less liquidity than traditional bonds, these alternatives offer the potential for greater income and diversification.
3. Implementing a Barbell Strategy
The barbell strategy combines long-term bonds with short-term 2and leaves out the intermediate-term ones. This method could mitigate long-term interest rate risk, while still taking advantage of the higher yields available in longer-dated securities.
4. Adopting an Active Approach
Future of active management in a low-yield environment Experienced managers can therefore identify very attractive opportunities across a range of fixed-income sectors and geographies after costs might generate alpha from security selection as well as tactical asset allocation.
5. Incorporating Dividend-Paying Stocks
Dividend-paying stocks are technically not fixed income, but they provide the potential for consistent cash flow and can be an excellent investable solution. Better off dividends…With their balance sheet strength and dividend consistency, companies such as GLEW themselves help you sleep better at night during what can be savage equity market conditions.
6. Utilizing Bond Ladders
A bond ladder is constructed by purchasing bonds with different maturity dates. This method helps to both neutralize interest rate risk and generate steady cash flow. When bonds mature, investors can often reinvest at higher rates only if yields have increased.
7. Considering Inflation-Protected Securities
In a low-yield environment, Treasury Inflation-Protected Securities (TIPS) and other inflation-linked bonds can provide an effective hedge against the erosion of purchasing power. Indeed, they provide little yield and so can be thought of as protection against surprise inflation.
8. Leveraging Structured Products
Market-linked CDs or notes: These are sometimes known as structured products and can allow you to participate in market appreciation while protecting on the downside. Such products however can be complex and carry additional risks, so thorough due diligence is necessary.
The Importance of Risk Management
While shifts in yield are top of mind for investors, Stahman advises that they should “not reach too far out on the risk spectrum while chasing return.” This includes:
Across asset classes, sectors, and geographies
Frequent portfolio rebalancing to target asset allocations
You asked us to continue our public offerings of new series and ongoing monitoring for credit quality, so we are.
Scenario stress testing of portfolios on a range of economic and interest rates
Conclusion: Adapting to the New Reality
The landscape of low yield proves to be a daunting environment for bond investors, but it also opens doors for those who are willing to transform with the space. Investors can improve their returns while managing risk by creatively thinking globally and evaluating new paradigms.
Always keep in mind that a universal formula does not exist. The right approach will vary by the investor based on your unique personal objectives, acceptable levels of risk, and timeframe. As always, remember to consult with a financial advisor to make sure your fixed-income strategy meets the objectives of your overall investment plan.
Through what seems like increasingly treacherous terrain, one fact is growing: the era of relying solely on sovereign and investment-grade corporate bonds to generate income looks broadly behind us. Shifting to innovation with fixed-income strategies can set investors up for success in this new low-yield environment.
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