Fixed income can still play a role in clients’ portfolios even after the Federal Reserve finally raises interest rates, but the purpose for the investment should determine what type of vehicle is used, said speakers on a panel discussion at the Morningstar ETF Conference in Chicago on Wednesday.
“What is the primary role for fixed income to play? Is it downside protection … or income generation? The answer will predetermine certain techniques,” said Anthony Parish, vice president for institutional research at Sage Advisory.
If the fixed-income investment is used as insurance, that generally entails higher-quality securities and a greater focus on duration-focused vehicles that are more affected by interest rates, he said.
In that case, “you shorten the duration and choose a yield-curve position to minimize vulnerability,” he said. “Don’t engage in the bad habit of panic selling, which is a carryover from the stock world. You can benefit from sector selection. Be sure you have the ability to tactically manage in your portfolio.”
Mark Mowrey, senior vice president and portfolio manager at AFAM Capital, said it’s also important to take a quantitative approach to the portfolio.
“That can take out the emotion from the investment decision,” he said. “Fixed income has been very emotional, which started to appear with the recent volatility seen. [Being quantitative] is going to be a more important feature of portfolios going forward.”
Financial advisors should also plan for a worst-case scenario, said Will McGough, senior vice president and portfolio manager at Stadion Money Management.
“That should be the number one concern for anyone investing in a capital asset,” he said. “Know why you need to sell it when [time or prices are] not favorable. Everyone wants to be in front of a waterfall event … but there may be times you need to sell.”
Parish said that while there has been a ton of focus on rising interest rates in fixed income, he believes the bigger risk is credit-rate risk.
“We’re getting to the mature part of the credit-rate cycle. We’re on track for an all-time record for corporate issuance and it’s done to generate a stock-friendly [view],” he said, and as a result his firm is reducing its allocation to corporate credit.
“At this point, duration is your friend,” Parish said. “I really think it’s going to be very difficult for interest rates to move meaningfully higher. The long end of the Treasury curve is driven by long-term growth, gross domestic product, employment and inflation. The short end tends to follow the fed funds rate.”
He said the Fed will eventually normalize interest rates, but that doesn’t mean the long end of the yield curve should be avoided.
All three panelists said they like high-yield investments rather than bank loans, but also stressed that investors need to be choosy because not all high yield is the same.