“All you have to get is a little bit better economic data coming from outside the U.S., and a little bit of improvement in investor sentiment, and that would make us too optimistic,” said Elswick. “Instead of the 10-year Treasury rising 30 basis points, it could rise another 30 or 40 on top of that,” causing a broad swath of the bond universe to lose value unexpectedly.
The managers differed on where investors can go if they want to eke some more significant returns out of the fixed-income portion of their portfolio.
Michael Natale, head of intermediary distribution at Northern Trust Asset Management, believes that with interest rates low, it’s a good time to invest in high-yield bonds.
“High yield is something we’re very high on,” said Natale. “We believe in a lower-for-longer rate environment. In that environment, there will be lower concerns around the defaults. We think, with spreads being in a positive place, high yield is a place where we can get positive returns.”
Khanna warned against seeking generic beta in the high-yield space and called for investors to use an active manager to avoid lower-quality investments.
Since fixed income is best looked at as a low risk, lower returning asset, Khanna also called on investors to embrace some longer duration bonds in their portfolio so that they might take better advantage of their diversification benefits.
“We do see value beyond the corporate space in structured products,” said Khanna. “These are asset-backed-securities instruments where you are secured with some underlying collateral on a pool of loans, and it requires more of a statistical analysis than an idiosyncratic analysis.”
Elswick, on the other hand, calls for investors to become more conservative and shorten their durations, noting that some value opportunities can be found in the “riskier” sectors of high yield.
“We would recommend selling, underweighting or otherwise reducing allocations to 15-year and 20-year investment-grade corporate bonds—even 10-year bonds,” said Elswick. “Even in the rates markets, Treasuries and other sectors like agency mortgage-backed securities, we would lighten up. The risk-reward of rate risk is uncompelling.”
Adams, who fell on the long-duration side of the argument, posited that emerging market bonds might be a better play for investors than the high-yield universe.
“Emerging-market central banks have a lot of room to ease policy, contrary to developed markets, if needed,” said Adams. “U.S. high yield looks really stretched. It looks tight given the economic growth we’re seeing., and to that point, we’ve seen a modest pickup in defaults.”
While all of the managers and allocators called for investors to seek an actively managed approach to fixed income, Khanna doubled down on the call by arguing that advisors and their clients should also avoid the urge to take a sector-by-sector approach to bonds.
“In fixed income, there’s no debate [that] there’s plenty of opportunity for active managers because it’s so inefficient,” said Khanna. “Financial advisors should be looking for a manager who has the resources to research fixed income and actively shift things around. If they’re just hiring a high-yield manager, a loan manager, an investment-grade manager, they’re taking on the responsibility of moving the asset allocation around themselves, and I’m not sure advisors with a small team around them will be able to go deep enough to orchestrate and understand all the different permutations and combinations of risks.”