"We think you can aim higher with your fixed income dollar"

Yields keep climbing. US treasuries have sold off again this week and bond yields across fixed income asset classes have risen higher. As we hit fixed income yields higher than we’ve seen in over a decade, many investors are asking their advisors why and where they can capture opportunity from what feels a bit like a paradigm shift.

Sam Acton sees a huge opportunity for investors in fixed income right now. The portfolio manager and partner at Picton Mahoney Asset Management believes that the right allocations in fixed income can generate a degree of yield, from a level of risk, that clients haven’t seen in a decade.

“This move higher in yields is creating some incredible opportunities in fixed income for advisors. High yields, and also low dollar prices are obviously a pretty attractive combination,” Acton says. “I think investors still need to be careful though. On the government bond side we still have an inverted yield curve, i.e. there are still cuts priced in.”

Acton explained that much of the recent move higher in yield, and sell-off in US bonds, has come from a market “pricing out” rate cuts. Where earlier in the year investors bought bonds expecting rates to get cut, the prevailing narrative has shifted to “higher for longer,” and investors are selling bonds as a result.

Adding to that, central banks have shifted from quantitative easing to quantitative tightening. Where they were previously a net buyer of bonds, they are now shrinking their balance sheets. At the same time, the US government is still running massive deficits covered by bond issuances, forcing investors to rethink bond prices.

The end result is a level of yield from fixed income that we haven’t seen for over 10 years.

While advisors and income-seeking investors may be jumping at the prospect of these yields, Acton still emphasizes that the right asset allocation is key. His firm advocates a diversified portfolio-building approach in bonds. At the same time, however, he sees particular opportunity in short-duration high-quality corporate bonds.

These bonds are typically rated between BB and BBB with three to five year durations. Right now Acton says he’s seeing yields on these bonds from between 6.5% and 8.5% at dollar prices of between $0.85 and $0.90. Not only are the yields attractive for the price, but Acton notes that much of that yield will come as coupon income and be treated as capital gains — which can help from a tax planning perspective.

Acton also sees some subsets of the fixed income space as being less attractive. While yields have gone up on GICs, for example, he argues that a flight to GICs means clients will be “leaving a lot of return on the table.” He notes that by locking your clients into an inherently illiquid product like a GIC, they won’t be able to pounce on any opportunities presented by market volatility. Moreover, if rates drop before the end of that term, the GIC won’t provide any capital appreciation. Acton notes as well that GICs lack tax efficiency and are still yielding at or around the rate of inflation.

“We think you can aim higher with your fixed income dollar and seek out that higher total return without taking on much incremental risk,” Acton says. 

Acton also sees a desire among some advisors to lengthen the durations of their fixed income exposure. While he believes those longer duration bonds are more attractive than they were five months ago, there is still an inverted yield curve and the market has now priced in rate cuts in 2024. Those longer duration bonds are, in Acton’s view, more rate sensitive and not as capable of withstanding further yield increases before total return turns negative.

One strategy that Acton advocates for is Picton Mahoney’s “Event Driven Credit Investing” approach. Rather than trying to predict macro narratives on rates, they look for events in the corporate space that can lead to greater bond returns. That could be a merger & acquisition, or a regulatory change, or a ratings upgrade or downgrade. The Picton Mahoney fixed income team tries to find those opportunities and, in doing so, opt out from what macro forces might do to fixed income returns.

As advisors talk to their clients about fixed income and bond returns, Acton believes they need to situate this asset class in a yield vs. risk framework. Just because yields look more attractive now than they have in years, doesn’t mean every fixed income investment is a winner.

“You really need to be careful with how you’re navigating the fixed income market and the corporate bond market,” Acton says. “For us at Picton Mahoney it’s a focus on short duration, high quality corporate credit, seeking out uncorrelated alpha opportunities through event driven credit investing, and the use of hedging and shorting tools to dampen volatility.”