Experts from leading investment firms weigh in on 'generational opportunity' and merits of barbel approach
While 2022 has given way to a generational opportunity in fixed income, investors would do well to follow a diversified approach in their portfolios.
That’s according to experts at Wealth Professional’s recently held Advisor Connect webinar titled “How ETFs can help you take advantage of market opportunities.”
“Generally, we tend to be pretty defensive,” said Rachel Siu, director of Fixed Income strategy at BlackRock Canada. “We are certainly getting to the end of the rate hike cycle in developed markets, … [notably with] the Bank of Canada on conditional pause.”
‘Generational opportunity’ in bonds
It’s not looking like a smooth descent. The end of Q1 saw tremors in the U.S. regional banking system with Silicon Valley Bank and First Republic succumbing to bank runs and weakness in their internal balance sheets. As the consequences of last year’s accelerated tightening cycle come to the surface, Siu said her team is leaning towards a tactically defensive position, with a preference towards higher-quality holdings within their equity book.
“We do prefer to take more risk in fixed income over equities,” she added. “Our view is that we are going to get to the terminal rate relatively soon. But we believe that we're going to be in a higher-for-longer regime, meaning we don't expect central banks to follow that old playbook of cutting rates right away when we see a slowdown.”
With that outlook of rates staying higher for the rest of 2023, Siu suggested bond investors will continue to see higher yield as an attractive play. For those looking for income opportunities while still staying high-quality and relatively low duration, she says staying on the front of the curve with yields around 4% to 5% is compelling relative to historical levels.
“There’s been a large regime change with yields moving up so much,” she said. “We’ve been very excited about that generational opportunity within bonds.”
Alfred Lee, director, portfolio manager and investment strategist at BMO ETFs, said the clear developing story for 2023 so far has been around expectations for central banks to dial down on interest rates. Many investors took the BoC’s conditional pause as a stepping-stone to rate cuts, though those bets may be receding in the face of stubborn core inflation. The Federal Reserve has yet to pause on interest rates, but data pointing to a slowing U.S. economy and softer hiring in March hint at an imminent dovish pivot.
“On the backdoor, [the Fed have] launched this BTFP program, the bank term funding program,” Lee said, referring to the U.S. central bank’s recent policy backstop instituted in the wake of SVB’s collapse. “They’re not calling it quantitative easing, but it looks and feels like quantitative easing. So because of that rates are coming down.”
He suggested it makes sense to take a little duration risk on both fixed income and equity at this point, as shown by flows back into technology stocks and long federal bonds. But as the year goes on, he’s anticipating a focus shift from the macro to the micro.
“After a while, people are going to become less concerned about what central banks are doing. And it's going to be more about what are the businesses that are going to be able to perform well, if interest rates are restrictively high for a longer period of time?” he said. “Higher-quality companies with strong balance sheets, same thing with fixed-income issuers … I think quality is going to be the theme with a lot of investors as the year progresses.”
Time for a bond barbell?
From his vantage point, Marcus Berry, vice president and ETF specialist at Invesco, agreed there are some opportunities to own long-duration fixed income today. But he also cautioned against taking too much risk on that conviction.
“If the market’s wrong, and inflation rears its head again, then long duration can really hurt investors,” he said. “The beauty with ETFs, from a fixed-income lens, is it allows you to achieve whatever it is that you want to do within your fixed income model. So whether you want to go ultra short duration, whether you just want to go three-year, five-year, seven-year, all the way up – [ETFs allow] you to customize it.”
With a “bonds are back” stance to back up its fierce support of the 60-40 portfolio, Vanguard is also seeing a generational opportunity for fixed income. According to Sal D’Angelo, head of product for Vanguard Americas, investors who fixate on the crushing 2022 losses in fixed-income are missing the fact that, from a 10-year standpoint, over 90% of fixed income’s total return has come from the coupon rather than the price return.
“We do believe high-quality investment grade bonds should form the ballast of any multi-asset portfolio,” D’Angelo said. “We are very constructive on that, and think clients should be rethinking their fixed income.”
Of course, it’s hard to have full conviction on interest-rate bets. D’Angelo noted that even professional managers – most of which look to futures or foreign markets to predict interest-rate movements – have only made accurate predictions about 7% of the time. Forecasts issued throughout Q1 this year have been all over the map to include soft-landing and hard-landing scenarios, as well as interest-rate movements in both directions.
“Professionals can't do it with success. It is very difficult for advisors to also do it,” he said. “If someone doesn't have a view, we believe an [aggregate-bond] approach or full duration approach makes complete sense in the context of a multi-asset portfolio.”
For investors to diversify their risks and capture opportunities across multiple outcomes, Berry says the most effective use of fixed-income ETFs would be through a barbelling approach.
“If you're going to take that long-duration play, make sure you've got some protection elsewhere in the portfolio,” he says. “Short duration might help counteract some of that that volatility.”
