A look at how fixed income strategies may help stabilize portfolios and enhance returns even in uncertain times.
AUTHORS
Jonathan Mondillo Head of US Fixed Income
George Westervelt Head of Global High Yield
In today’s financial landscape, market volatility has become a significant concern for investors.
Even while recession risks fade and inflation slows, news about the market has shifted to a list of concerns and uncertainty as fears of the political climate and overall global unrest have contributed to recent volatility.
Uncertainty in the stock market is often the biggest cause of investors experiencing what most would consider to be emotional roller coasters. Stocks can be down triple digits one day and up the same amount the following week – or possibly even the next day.
And although the markets may be on a roller coaster ride, ideally, investors’ emotions should not be on that same ride. Fortunately, through all the market volatility we have seen recently, successful strategies can still help alleviate the ups and downs of typical investor emotions during hyperactive markets.
Whether already invested in or considering fixed income, understanding how to navigate in this changing-rate environment is crucial. While municipal (muni) and corporate bonds can still be subject to market fluctuations, they can also provide a solution to investors looking to mitigate equity volatility while generating income.
We explore how three potential solutions – ultrashort municipals, short-duration high yield municipals, and high yield corporates – may help mitigate these risks.
1. Ultrashort munis
Ultrashort munis are debt securities with very short maturities, typically less than one year. These bonds are designed to provide liquidity and preserve capital while offering a modest yield. Due to their short maturities, ultrashort municipal bonds are generally less sensitive to interest rate changes, making them a potentially stable option during periods of market volatility.
Additionally, these bonds can be easily bought and sold, providing investors with quick access to their funds if needed. Like other munis, the interest earned is often exempt from federal income tax and, in some cases, state and local taxes.
However, the trade-off for stability and liquidity is typically lower yields than longer-duration bonds. Frequent maturities mean investors may need to reinvest their principal at potentially lower interest rates, introducing reinvestment risk.
Despite these considerations, investors looking for a potential safe haven during turbulent times might consider allocating a portion of their portfolio to ultrashort munis. In addition, given the inverted yield curve in the municipal market at this time, investors are being paid to wait to extend duration as short-term yields are currently above intermediate yields.
We believe ultrashort munis is a strategy that may provide a buffer against market swings while maintaining some level of income.
2. Short-duration high yield munis
Short-duration high-yield munis have effective durations ranging from one to five years and generally offer higher yields due to their lower credit ratings than investment-grade bonds. These bonds can provide higher income, making them attractive for investors seeking more substantial returns. While they carry more risk than investment-grade bonds, their shorter duration helps mitigate some interest rate risks – offering a balance between risk and reward.
However, higher yields come with higher credit risk, meaning there’s a greater likelihood of default than higher-rated bonds. Additionally, although less sensitive than longer-duration bonds, short-duration high yield bonds can still be affected by market conditions and interest rate changes.
We believe short-duration high yield munis can appeal to investors willing to take on a bit more risk for higher returns. We would promote a sophisticated approach to this market, as a prudent investor should diversify across various issuers and sectors to help manage the credit risk associated with these bonds.
3. High yield corporates
The high yield corporate market offers investors an opportunity to capture a relatively high level of income while moving up the capital structure in terms of seniority versus that of equities.
While many retail investors may prefer the more publicized equity market, adding an allocation of high yield corporates can be an excellent way to increase portfolio diversity while potentially limiting downside in a volatile market.
Today’s high yield market is higher in quality versus those of previous market cycles given the balance sheet repair that has occurred over recent years. With a yield of over 7% (yield to worst)1, we believe investors in the asset class can cushion total return prospects in a downside scenario while capturing the benefits of duration in an environment where central banks will soon be pivoting towards rate cuts.
Final thoughts
Navigating market volatility requires a strategic approach tailored to individual risk tolerance and investment goals. An ultrashort strategy may offer stability and liquidity, making it a potentially safe choice during uncertain times. A short-duration high yield strategy may provide a balance of higher income with moderate risk, suitable for those willing to accept some level of credit risk. Lastly, an allocation to high yield corporates may limit downside versus equities, due in part to a relatively high level of income that has the ability to cushion total returns.
By understanding these options and incorporating them into a diversified portfolio, we believe fixed income investors can better manage market volatility and work towards achieving their financial objectives.
1 Bloomberg U.S. Corporate High Yield Bond Index, September 2024.
Important information
FOR PROFESSIONAL INVESTORS ONLY. NOT FOR USE BY RETAIL INVESTORS.
Projections are offered as opinion and are not reflective of potential performance. Projections are not guaranteed and actual events or results may differ materially.
Fixed income securities are subject to certain risks including, but not limited to: interest rate (changes in interest rates may cause a decline in the market value of an investment), credit (changes in the financial condition of the issuer, borrower, counterparty, or underlying collateral), prepayment (debt issuers may repay or refinance their loans or obligations earlier than anticipated), call (some bonds allow the issuer to call a bond for redemption before it matures), and extension (principal repayments may not occur as quickly as anticipated, causing the expected maturity of a security to increase).
Foreign securities are more volatile, harder to price and less liquid than U.S. securities. They are subject to different accounting and regulatory standards, and political and economic risks. These risks are enhanced in emerging markets countries.
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