Are we in a new era for fixed income?

For the past 10-15 years, Benjamin Chim heard the same complaints from investors: ‘there’s no return on fixed income.’ The Vice President, Director & Portfolio Manager at TD Asset Management Inc. (TDAM) explains that due to almost a decade and a half of near-zero interest rates, advisors and investors saw fixed income losing its utility as a retirement solution or a component of a balanced portfolio. The 60/40 fell dramatically out of favour as other products hit the market to deliver the yields investors couldn’t get from fixed income. These assets were, primarily, a tool for capital preservation.

That dynamic has changed dramatically over the past two years. Inflation and steep interest rate hikes introduced volatility and opportunity to the fixed income market. As interest rates appear to be peaking, and speculation rages around central bank interest rate cuts, Wealth Professional is hosting an Advisor Connect event. The online panel discussion called the beginning of a new era for fixed income will feature Chim and other fixed income experts explaining the new dynamics in fixed income today and what advisors need to know about these assets going forward.

“The volatility completely changed the dynamic. The protection component didn’t hold up as well as people had wanted, but at the same time it really creates opportunities in the future with yields now significantly higher,” Chim says. “Fixed income has a much better place in retirement portfolios and a much better place in all portfolios. With yields above five or six per cent, high yield products above nine per cent, the long-term return profile is quite enticing. Going forward we will also see a transition among central banks towards cuts, which will likely mean the volatility falls and the protection role will improve.”

While fixed income failed to pay high enough yields, or when its volatility spiked, Chim says many investors took shelter in high interest savings exchange-traded funds (ETFs) and other cash equivalents. While those investors may get some of the yield component, they are currently missing out on the possibility of capital appreciation when yields fall slightly. The balance has shifted toward fixed income, in Chim’s view, that a 60/40 allocation or even a slight overweight to fixed income makes sense to him.

Chim also specializes in corporate bonds within the wider area of fixed income. Corporate bonds, he accepts, have done somewhat better for investors in the past, as they tend to have more positive exposure to strong economic times and offered higher yields than government bonds. Chim still believes that corporate bonds can perform in this new era for fixed income.

“This economic backdrop kind of gives you a nice sort of happy medium spot where you can generate some good returns while still benefiting from the economy being stronger than we expected and higher rates overall,” Chim says. “You don't need then to have the thesis that rates are going to fall to make good returns from credit.”

On a structural level, Chim sees fixed income working in the longer term because we appear to be headed into a period of structurally higher inflation. Demographics, debt levels, decarbonization, and deglobalization look set to put more upward pressure on prices for the foreseeable future. If inflation stays closer to 3 per cent long-term, we should expect central banks to keep rates relatively high, preserving that yield component of fixed income assets. That doesn’t mean we won’t see rate cuts in the near term, though. Broad consensus is that the Bank of Canada will cut rates in the spring or summer this year which should spur both greater stability and opportunity for upside in fixed income assets.

At the event, Chim and his fellow speakers plan to delve deeper into the outlook for fixed income, how its dynamics are changing, and how key decisions like duration and subsector can help advisors show their value to clients.

“I think many [advisors] are still on the fence around long-term returns for bonds. I’m hearing a lot about valuations being difficult on credit markets, or that inflation data is too sticky. Through all of that advisors are still quite nervous about having an allocation to fixed income in their portfolios,” Chim says. “I think now, more than ever, it’s very important for investors to take advantage of the fact that we’re at this crossroads of peaking rates and hikes moving into cuts. While we’re seeing volatility, I think that creates opportunity that advisors would do well to take advantage of.”

Chim will present more of his insights on fixed income at the WP Fixed Income Advisor Connect on March 26th. Register here.