These days, you are no doubt talking to clients about what to do with the fixed income allocation in their portfolios.
Concerns about central banks’ policy normalization in the face of high global inflation and market volatility, along with a rising interest rate environment, have combined to make the fixed income decisions you make for your clients tougher than ever.
Stick with your plan … especially when it comes to bonds
The benefits of bonds are timeless. They provide a buffer against equity market fluctuations, while producing income that can grow from the compounding effect of reinvested interest payments. It would be unusual indeed to have a portfolio without them.
As you meet the challenges of creating thoughtful, well-diversified fixed income allocations for your clients, here are four strategies to keep in mind.
1. Stay diversified
Be clear on the role of fixed income in your clients’ portfolios. Your clients should own bond funds as a diversifier to equity risk—even with interest rates moving higher. The chart below shows projected returns of various assets during the expected worst decile of monthly U.S. equity performance over the next 10 years.
2. Maintain a proper risk profile
Lately, many advisors have chosen to shorten duration in order to reduce their clients’ interest rate risk exposure, filling the yield gap with high-yield or emerging markets fixed income securities, for example, thus increasing credit risk. This may look great on paper, as these sectors are expected to earn, on average, higher returns. However, this approach can lead to a more equity-like fixed income portfolio that may not perform as well during a stock market correction or bear market.
3. Harness duration
Although it’s a seemingly obvious decision, it’s worth repeating: Construct portfolios tailored to the appropriate time horizon.
Even rising rates can be good for bond investors if their investing time horizon is longer than the portfolio’s average duration. Higher yields on reinvested cash flow should outweigh market price declines. There may be some short-term pain, but your clients should be rewarded over time. If the investment horizon is shorter than the average duration of the portfolio, consider adjusting it to align the two more closely.
4. Take control
How you implement the fixed income allocation of your client portfolios depends on how much control you want to have. You may choose to have full strategic control and make allocation decisions across the different sectors in fixed income. Alternatively, you might choose to hire an investment manager to do this for you. Or, depending on your expertise, you may choose to do something in the middle.
What’s the bottom line?
Fixed income investing is challenging these days. But it’s not just fixed income investments that face headwinds in the markets. The next 10 years are probably not going to look like the last 10 years for any asset class.
We believe maintaining portfolio diversification and the right risk profile, harnessing duration, and taking appropriate control of allocations can go a long way in helping you position your clients to achieve success.