Tony Rodriguez,
Co-Head Fixed Income,
Nuveen Asset Management
Taxable Fixed Income Outlook: Riding the Rate Roller Coaster
While active managers can add value through interest rate positioning, predicting rates in the short term is a tricky task. Despite widespread fears of rising rates this year, yields confounded investors again by declining. We believe investors can position their bond portfolios for this rate roller coaster using actively managed, broadly diversified, multi-sector bond strategies. These portfolios have many return drivers, in addition to interest rate positioning, that we believe can help make the roller coaster more like a Sunday drive.
Interest rates can be incredibly unpredictable, and this cycle has been exactly that. Just when everyone felt certain that Federal Reserve (Fed) tapering of asset purchases would cause rates to rise, they fell.
Many ask why rates remain so low. The puzzle is complicated because so many factors affect interest rates. These include fundamental factors such as growth rates, inflation expectations, preference for shorter-term securities, and investor risk appetite. In addition, technical factors that drive the supply and demand dynamics have had greater impact lately.
This more tactical buying or selling of larger positions can impact rates. However, it is important to remember these shorter-term technical situations don’t change the longer-term fundamental trends that will inevitably unfold. Unless the economy derails, it is likely that rates will rise modestly over the intermediate term.
Let Active Managers Help Smooth the Ride. Even for the most experienced managers, positioning for short-term rate changes can be tricky. Rather than trying to time the market, consider selecting a multi-sector bond strategy that gives the manager the necessary flexibility to position for changing markets. In addition to managing portfolio duration and adjusting yield curve positioning, sector selection can help protect against rising rates. A portfolio that can move among many market segments may be better positioned to ride out the rate roller coaster.
For more information on Nuveen Asset Management please see our profile on page 74.
Bob Jolly
Head of Global Macro,
Portfolio Manager,
Schroder Global Strategic Bond Fund
Risk Rotation Rather Than Sector Rotation
We ran out of road. In the aftermath of the financial crisis, investors reallocated their cash into government bonds, added high-grade credit, then rotated into high yield and emerging market debt, and finally opted for less liquid segments of the market such as private loans and direct lending. So what to do next? Selling your bonds?
Global demographics will increase demand for bonds. Fixed income securities are widely used for collateral in derivative transactions, and recent regulatory changes mean that more transactions will need to be collateralized going forward. In addition to these rather technical reasons, fixed income will continue to perform the tasks it has always performed: generate income, diversify your portfolio and reduce the overall risk of your portfolio.
We live in a world of growing divergence. The U.S. economy is growing at a healthy pace, its banking system has been restored to health and the monetary policy will most likely shift to a less accommodating stance shortly. On the other hand, Japan and the Eurozone struggle to create growth, have an inefficient and still undercapitalized banking system and will have to loosen monetary policy to fight deflationary pressures. Add to that that most of the major central banks are now using the exchange rate to set their monetary policy, and lots of opportunities become available to investors who can adopt a global strategy that has the flexibility to seize these opportunities. Traditional bond portfolios will struggle with rising interest rates.
These unconstrained strategies allocate risk to interest rate, currency and credit strategies with the aim to generate positive returns regardless of the direction of interest rates, credit spreads or exchange rates. So rather than looking for the “next promising sector”, it is much better from a risk/reward perspective to embrace flexibility.
For more information on Schroders please see our website at www.schroderfunds.com and our profile on page 74.