Prudential’s first quarter outlook predicts that fixed income is poised for an upside surprise despite the stock market’s downturn.
"The areas of most interest are higher quality structured product sectors and AA and AAA have the best risk reward while offering little credit risk,” said Robert Tipp, chief investment strategist with Prudential Fixed Income and a manager on the Prudential Total Return Bond Fund (PDBAX), who hosted a recent outlook call focused on fixed income.
The new year is off to a rocky start with slower growth in China, falling oil prices, geopolitical instability and the threat of bankruptcies in junk bonds, all of which contribute to prolonging the volatility that marked 2015.
“While we do not believe the stock market will end the year with a significant decline, we do think that volatility will be a recurring theme in 2016 marked by several intermittent starts and stops in the stock market,” said Bill Walsh, CEO of Hennion & Walsh
Tipp noted that pressure from hedge funds’ forced-selling is pushing spreads out to levels that create buying opportunities for funds with cash to put to work.
“The impression we have is that some hedge funds have been experiencing withdrawals because of a difficult performance environment,” Tipp said. “Buying as spreads widen is an area we’ve had exposure to and that we are actively looking at.”
Investment grade municipal bonds and preferred securities are among the asset classes that have traditionally performed well during periods of heightened stock market volatility.
“In some cases, high-rated collateralized loan obligations (CLO), commercial mortgage backed securities (CMBS) and other structured products offer spreads in the 1.5% and 2% range,” Tipp told Financial Advisor. “We see these as very attractive and that’s before going into the lower-rated area of investment grade whether that be in financials or whether you move into high yield again away from the extraction sector.”
Karissa McDonough, chief fixed-income strategist with People's United Wealth Management, recommends advisors focus bond portfolios on core bond allocations, such as treasuries, government securities, mortgages and investment grade corporate bonds.
“Core bond allocations now represent more than 80% of our tactical fixed-income portfolio, which is a 10 percent to 15 percent rise over the allocation we had recommended to clients two years ago,” McDonough said. “In taxable portfolios, municipal positions may be substituted for a large portion of the core allocation depending on the client’s tax bracket.”