Thoughts from our Fixed Income Team
As we approach the halfway point of the calendar year, nervousness has become the dominating characteristic throughout the credit markets. Bond investors who more commonly decide to buy and sell positions based on mathematical evaluations such as yield, safety and duration seem to have been overrun by a stampede for the exits. Over the last few weeks, hearsay, speculation, policy uncertainty and no small amount of illiquidity have ruled the roost, and enormous money flows out of all sorts of risk assets have weighed heavily on prices. How then, we must pause to ask, do you quantify flaring emotions?!
It has, in any case, been a trying few weeks as the performance of every major fixed income sector has slid into negative performance territory year-to-date. Little of the fundamental story of an improving domestic economy, led most significantly by housing, and an aggressively accommodative Federal Reserve Board, has changed. Prices for fixed income instruments, which were admittedly so rich to historical levels only a few weeks ago, have declined to price points which could have been only imagined for quarter after recent quarter. What just happened; where is this heading; is the bond party over forever?
We have always divided fixed income investors into three distinct camps: rate speculators; asset allocators and income seekers. The violent short-term shift of recent days hammers home the difference as to how each type will address these questions. If the investor’s main objective is to profit from sudden turns in interest rates (the speculator), then, well, good luck with that. We hope you’re on the right side of changes more often than not. We, however, do not believe that the rest of us mortals can more than occasionally anticipate rate shifts, when even those who control where rates are heading (and equally importantly at what time point) seem to have little idea themselves.
Bond investing is a bit easier in this respect during disruptive times for asset allocators. Their fundamental question is more centered on whether there is another asset class which will prove more profitable than bonds going forward. They take what the bond market giveth, perhaps adding an incremental degree of relative performance from time to time, and focus primarily on sector rebalancing evaluations rather than laboring too seriously on determining the exact next direction of rates.
Market volatility is the least worrisome, in any case, for the more patient income investor. Those who utilize fixed income portfolios mainly to produce steady and predictable cash flows, in fact, stand to collect nearly identical amounts from his or her portfolio as they were enjoying prior to the tumultuous declines of the past few weeks. And equally as calming, the pure income investor may stand to benefit further from rising rates over time since the income from their bond portfolios should improve through better reinvestment opportunities and higher coupon compounding. Income investors focused on a longer-term horizon therefore welcome higher rates; they should make more money.
Submitted by: Howard Potter - Managing Director, Senior Fixed Income Portfolio Manager
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