The economic fallout from the global pandemic has reshaped fixed income markets, forcing investors to adjust portfolio strategies in the search for yield.
“The portfolio you had a year ago has to be really different from the portfolio you have today,” said Rick Rieder, BlackRock’s chief investment officer of global fixed income.
Rieder spoke on a digital panel Wednesday at the 2020 Morningstar Investment Conference alongside Anne Mathias, a senior strategist in Vanguard’s fixed income group.
Federal Reserve chair Jerome Powell’s announcement last month that the Fed would keep interest rates near zero even after inflation has exceeded the 2% target level is extremely significant, Mathias said.
Maintaining nominal interest rates at a level below where they normally would be in an inflationary environment makes it easier to service debt, creates a longer credit cycle and creates the potential for asset prices rising further, she said.
The upshot is a “golden age for active investing in fixed income,” Mathias said. “You’re not going to get paid on the beta.”
A report this month from CIBC World Markets about the low-rate environment said federal government bonds, as an asset class, are now equivalent to cash and have “essentially disappeared as a way to make money.”
A Mackenzie report called low yields “the new paradigm for long-term investors, rather than a cyclical bump in the road.”
Fed programs have created so much liquidity, the panellists said Wednesday, that portfolio managers need to scrutinize securities in the lower segments of sectors they’re interested in to find attractive risk-return.
“The high-yield market has become, to some extent… a Frankenstein market,” Rieder said. “A lot of the high-yield market is too rich now, because everybody’s searching out the yield. Then you have parts that are distressed.”
Combining those elements does not make a stable strategy, he said. Instead, investors need to consider bespoke opportunities that require a lot of research, and they may want to sit in cash rather than investing in fixed income segments “that are already too rich.”
The distinction between high-yield and investment grade also matters less than the sector, Rieder said. He would rather buy BB healthcare securities than higher rated energy ones, for example.
Mathias said emerging markets should benefit from Fed policy, notably low rates and asset purchases that may put downward pressure on the dollar. She recommended countries that are less sensitive to energy markets and more oriented toward resumption in trade, which she expects to rebound since people are still consuming.
Investors should prioritize countries that are more fiscally responsible rather than just going for the cheapest securities, she said.
Investors may also need to reconsider the 60-40 portfolio. A higher equities concentration makes sense, Rieder said, as does alternatives taking a portion of the fixed income mix, whether that’s in infrastructure or private lending. It’s also a good time for cash alternatives.
“Fixed income still works,” he said, but the return potential is smaller and the strategy has to be more targeted.