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Expected interest rate hikes by the Federal Reserve have produced volatile fixed-income markets that are extremely challenging for many investors. But in spite of the uncertainties, financial advisors know that bonds add needed diversity to portfolios and are less risky than stock over the long term. They deliver income on a schedule to investors who need cash flow in retirement.

Here, bond portfolio managers offer their outlooks in commentaries that provide valuable insight on what financial advisors should consider when deciding how to allocate clients’ money to this essential asset class.

Rob Galusza,
Portfolio Manager,
Fidelity Investments

Enhancing Bond Fund Total Return
In the current bond market environment, investors see low yields and the specter of higher rates as a threat to their fixed-income allocations. In contrast, active bond fund managers see this environment as an opportunity to help clients meet their fixed-income objectives. They have a number of active strategies with the potential to enhance total return: 1) carry, 2) rolldown, 3) yield-curve changes/reshapings and 4) yield-spread changes. Rolldown is one of the most critical in today’s environment.

Investors typically demand higher yields to lend money for longer periods of time, so the U.S. Treasury yield curve, a proxy for the risk-free yield curve, is characteristically upward sloping. Rolldown is a strategy used by active bond fund managers to complement a bond investment’s income generation. The steepness of the yield curve dictates the degree of its contribution to return. This strategy can enhance a bond’s total return in a rising interest rate environment and allow an investor to benefit from a steepening yield curve. It works best when the yield curve remains upward sloping and when rates rise less than the markets are predicting.

Consider the steepness of the current risk-free yield curve. While the fed funds rate continues to be pegged between 0 and 25 basis points, and there have been fits and starts in the pace of U.S. economic growth so far, investors have priced an unwinding of the Fed’s QE program into the market. This has contributed to higher yields for longer maturities. The resulting yield-curve steepness, especially between two- and five-year maturities, can present attractive rolldown opportunities, which can enhance total return.

In our view, investors need not give up the benefits of bond funds in a well-balanced portfolio to protect their assets from the possibility of higher interest rates. They can potentially maximize their total-return prospects through active bond fund strategies that exploit carry, rolldown and yield-curve and spread changes. To effectively do so, investors need to identify their investment horizons and understand the potential benefits and trade-offs certain bond fund investments pose.

For more information on Fidelity Investments, please see our profile on page 72.

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