The fixed income investing landscape has changed and investors may want to reconsider how they are thinking about risk and opportunity within this asset class. The US Federal Reserve (Fed) has ended the quantitative easing (QE)1 program it undertook in response to the 2008 Global Financial Crisis. In June 2018, it raised interest rates for the seventh time since December 2015 — and subsequent upticks are expected. The European Central Bank (ECB) is likely to begin winding down its QE program by the end of the year.

Investors are concerned
Evidence suggests that rates are weighing on the minds of many investors. According to the Natixis Global Survey of Institutional Investors2, interest rates rank as the top portfolio risk for institutions in 2018. In fact, they see rising rates as a bigger portfolio risk than asset price volatility. Six in ten institutions believe interest rate increases will have a negative impact on portfolio performance in the year ahead, while seven in ten believe bond volatility will increase over the next year. Seven in ten institutions also say individual investors have taken on too much risk in pursuit of yield.

In addition, about half of the wholesale portfolio managers and family offices surveyed by Natixis worry that the unwinding of quantitative easing will have a negative impact on portfolio performance. Nearly six in ten family offices are concerned that monetary policy will have a negative impact on performance. Lastly, a recent report by Loomis, Sayles & Company suggests that a 50 basis point (0.50%) increase in interest rates could wipe out a year of income on an intermediate bond portfolio.

Where might fixed income investors turn?
Foreign bond yields remain so low that US fixed income rates may continue to look attractive to some investors. However, it may be necessary to move down in quality to pick up meaningful yield – which also translates into increased risk. In 2017, short term bond and ultra-short term bond mutual funds saw big inflows, possibly indicating that investors would prefer to park money on the sidelines for a bit, rather than go into longer duration products. Managing duration may become easier as the yield curve flattens – a “flattening yield curve” refers to a scenario in which short and long-term bond yields are closer together. In this case, it may not cost investors as much in terms of foregone yield to shorten duration.

Considerations for a challenging fixed income market
According to the Natixis Portfolio Research and Consulting Group (PRCG), 38% of fixed income assets are allocated to intermediate duration investment grade assets3. These allocations may be particularly yield curve and interest rate sensitive, because many comprise mortgage-backed securities. What’s more, PRCG calculates that only 6% of fixed income assets are allocated to floating rate securities, suggesting that this asset class could be under-owned. Financial professionals and individual investors may want to check their fixed income holdings to see how much exposure they have to interest rate-sensitive allocations, while making sure they take into account both the risks and opportunities that a rising rate environment could create.

 


1 Quantitative easing (QE) refers to the introduction of new money into the money supply by a central bank.

2 Natixis Investment Managers, Global Survey of Institutional Investors conducted by CoreData Research in September and October 2017. Survey included 500 institutional investors in 30 countries, 200 professional fund buyers in 23 countries, and 100 US family offices.

3 Natixis Portfolio Research and Consulting Group (PRCG). US Trends Report. Winter 2018. Figure 11.

This material is provided for information purposes only and should not be construed as investment advice.

The views and opinions expressed may change based on market and other conditions.

Fixed income securities may carry one or more of the following risks: credit, interest rate (as interest rates rise bond prices usually fall), inflation and liquidity.

Mortgage-related and asset-backed securities are subject to the risks of the mortgages and assets underlying the securities. Other related risks include prepayment risk, which is the risk that the securities may be prepaid, potentially resulting in the reinvestment of the prepaid amounts into securities with lower yields

Interest rate risk is a major risk to all bondholders. As rates rise, existing bonds that offer a lower rate of return decline in value because newly issued bonds that pay higher rates are more attractive to investors.

Floating rate loans are often lower-quality debt securities and may involve greater risk of price changes and greater risk of default on interest and principal payments. The market for floating rate loans is largely unregulated and these assets usually do not trade on an organized exchange. As a result, floating rate loans can be relatively illiquid and hard to value.

Duration: A bond’s price sensitivity to interest rate changes.

Yield curve: A curve that shows the relationship among bond yields across the maturity spectrum.

All investing involves risk, including the risk of loss.

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