After a multi-decade bull market in bonds, fixed income has become a decidedly bearish environment. The threat of rising interest rates has caused a spike in yields and driven down the price of longer-dated maturities with startling speed. As well, key central bank rates are effectively at zero, making income generation difficult. And returns aren’t always keeping up with inflation – in fact, real yields are often negative. This article looks at how we are addressing these challenges by broadening our source of returns, and why bonds - despite the current headwinds - should still be considered a key part of your plan members’ portfolios.
Despite the threat of rising interest rates, we believe that fixed income securities will continue to be important building blocks in target date funds and plan member portfolios. Over time, fixed income securities have provided four key benefits:
Given the current market conditions, it can be challenging to generate income, find liquidity and preserve real (inflation adjusted) capital over longer periods. Indeed, Canada’s broad fixed income market currently generates an average annual yield of around 1.7%. This is below the 2% mid-point of the Bank of Canada’s target inflation range of 1% to 3%.
Canada’s broad fixed income market has a strong bias towards high-quality, lower- yielding government issues. And it has a fairly narrow corporate opportunity set, challenging the longer-term return and income generation potential of this traditional core building block.
|Modified duration||7.92 years|
Source: FTSE. Data as at March 31, 2021.
Given this, a broader source of bond return drivers can play an important role in enhancing returns. To effectively construct such an allocation, we focus on:
We believe that over the long-term fixed income will continue to play a pivotal role in portfolio protection. As such, we continue to take a holistic view of fixed income within the broader portfolio, believing that while interest rates are historically low, fixed income should continue to support portfolio protection and diversification. In addition, positioning within the fixed income market is equally important. And given today’s market conditions, this makes understanding the role of various underlying components of a fixed income portfolio more critical than ever. To that end, the role of multiple building blocks, return sources and tactical asset allocation will be key to navigating the current yield environment.
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