A new case for fixed income, covering market trends and more

It is no secret that the traditional 60-40 portfolio has suffered over the last 7 months, with Investors getting hit on both sides of the asset allocation spectrum. Although the current Inflationary environment was predictable when considering the stimulus introduced in the Financial System over the last 2 years, it was much harder to predict the relaxed approach taken by Central Banks in the early months of the year, followed by a seemingly sudden pivot in their policy response. 

Starting in March, we began seeing Central Banks across North America as well as the Bank of England raise interest rates as a precaution, and quickly evolved into one of the most aggressive Rate Hiking Cycles in the United States and Canada in the last 25 years:

Over the first 7 months of 2022 the Federal Reserve and Bank of Canada raised interest rates at an incredible pace, dwarfing the previous rate hike cycle from 2016-2019. Given the negative relationship of most asset prices to prevailing interest rates, it is hardly surprising that portfolios have had a tough year so far, regardless of allocation. 

The winds of change

More recently however a new trend has started developing, which sees fixed income earn back its spot in investors’ portfolios. As of August 5th, global bond funds experienced their biggest weekly inflow in almost a year, with net purchases totaling $14.4 billion dollars since November 2021, while at the same time global equity funds suffered outflows of roughly $10.5 billion. Although equity outflows have been common over the last 2 months, this marks the first time since early June that investors have started taking sizeable positions in fixed income, which is indicative of a shift in their risk sentiment and forward interest rate projections. As Figure 1 demonstrates, bond inflows in August saw a considerable spike when compared to the previous 8 weeks, while money market funds also saw a modest increase.

Figure 1 - Fund flows: Global equities, bonds, and money markets

A closer look at the bond inflows data shows a very interesting trend; investor appetite is shifting from short-duration government bonds, traditionally considered some of the safest assets even in the fixed income space, to investment grade and High Yield Corporate bonds particularly focused in the U.S. It is worth noting that LQD, the U.S. investment grade corporate bond segment in the Trackinsight ETF database was still down 15% year-to-date as of August 19, 2022. This “buy the dip” phenomenon enforces another developing trend, which sees the yields on short-medium term corporate bonds now equal to, or in some cases higher than the dividend yields on the associated Blue Chip stocks. This shift in the underlying fundamentals is allowing income-focused investors to capture a similar yield as that provided by common stocks, without taking on the inherent volatility that comes with an equity investment. At the same time, the longer duration on these bonds allows the investors to capture more upside on the underlying price of the bond in the event of another pivot from Central Banks, which will see interest hikes stop, or potentially reverse in H1 2023.

Figure 2 - Global bond fund inflows 

Gaining exposure

With the changing economic environment, some investors may wish to rebalance their portfolios to include some exposure to fixed income and capture the benefits of higher yields for comparatively lower risk. There are plenty of available ETFs that allow for this diversification to happen, such as VCIT and CORP. They are an excellent way of diversifying individual bond holdings while taking advantage of the overall trends in corporate fixed income, coupled with low management fees and the experience of two of the largest asset managers in the world. Investors with a particular focus on ESG investing can also consider HYG, which provides exposure to high-yield corporate bonds and has a strong consideration for ESG components, with 85% of its holdings being vetted through an ESG lens.