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More Income in Fixed Income

The bond market in 2022 has been turbulent and the negative total returns have been some of the worst experienced by fixed income investors.  As a result, a substantial amount of pessimism has been created for the asset class so far this year.  However, a reason for optimism has also been created for fixed income investors as there is now more income in fixed income.  As shown below, the yield on the Bloomberg U.S. Aggregate Index, a proxy for the broad bond market, was 3.98% as of 6/21/2022, an increase of 279% from its all-time low of 1.05% on 7/31/2020. 

Source: Bloomberg Indices.

Fixed income investors now have an opportunity to take advantage of this repricing and generate more income in their portfolios.  Actively managed bond portfolios can now reinvest at these higher interest rates, while buy and hold bond portfolios can lock in these higher yields until maturity.  Additionally, income focused investors will likely find the yield profile of investment grade and high yield corporate bonds looking more attractive compared to recent history, as well as to stock market dividend yields as shown below.

Source: Bloomberg Indices, ICE BofAML Indices, Bloomberg. 

Unlike the yield side of the discussion, index durations have not changed much so far this year and remain historically high.  The duration on the Bloomberg U.S. Aggregate Index was 6.41 years as of 6/21/2022, which is down slightly from its all-time high of 6.78 years on 12/31/2021.  Over the last several decades, as yields have trended lower while durations have trended higher, the risk/reward profile in the bond market has become more challenging as fixed income investors have been forced to accept less yield while taking on more duration risk as shown below. 

Source: Bloomberg Indices. 

The pandemic and the Federal Reserve’s corresponding response caused some extremes in the bond market regarding levels of yield and duration.  As the market now attempts to normalize while the Federal Reserve reduces monetary accommodation, the risk/reward profile in fixed income has improved.  As of 6/21/2022, the Bloomberg U.S. Aggregate Index had 0.62 units of yield per unit of duration, which is 265% higher than its all-time low of 0.17 units of yield per unit of duration on 7/31/2020.  As shown below, these are levels not seen since the fourth quarter of 2018 and highlights a more attractive return profile.

Source: Bloomberg Indices. 

Downside risks are still present in the bond market, and yields could still go higher from here.  Chasing yield is not a prudent investment strategy, but the pain that has been felt so far this year has created an opportunity to enhance the income generation potential within a fixed income portfolio, which should be a welcome sign for long-term investors.  The higher yields today offer a more attractive entry point and a better risk/return profile compared to the depressed levels of yields that dominated the bond market during the heights of the pandemic.  Most bond managers are inherently pessimistic regardless of market conditions, as downside protection is typically a primary objective, but more income in fixed income is a reason for optimism.

 

The views expressed herein are presented for informational purposes only and are not intended as a recommendation to invest in any particular asset class or security or as a promise of future performance.  The information, opinions, and views contained herein are current only as of the date hereof and are subject to change at any time without prior notice.

*Source: Bloomberg Index Services Limited. BLOOMBERG® is a trademark and service mark of Bloomberg Finance L.P. and its affiliates (collectively “Bloomberg”). Bloomberg or Bloomberg’s licensors own all proprietary rights in the Bloomberg Indices. Bloomberg does not approve or endorse this material or guarantee the accuracy or completeness of any information herein, nor does Bloomberg make any warranty, express or implied, as to the results to be obtained therefrom, and, to the maximum extent allowed by law, Bloomberg shall not have any liability or responsibility for injury or damages arising in connection therewith.

 

Justin Waggoner

Executive Vice President, Senior Portfolio Manager
Boyd Watterson Asset Management, LLC

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