Income Generator: Back in Bonds

• By: admin
• On: 11/08/2023 15:07:59
• In: News
• Comments: 0

This is an excerpt from NCPERS Fall 2023 issue of PERSist, originally published October 24, 2023.
 
In early 2023, many financial pundits declared “bonds are back.” In reality, though, bonds never left—and after suffering violent revaluation in 2022 as well as significant yield increases across the entire curve and up and down the ratings spectrum, we believe they're back to doing what bonds are designed to do:

1. Generate a steady stream of predictable income.
2. Provide a buffer against future price volatility.
3. Diversify a broad investment portfolio against cyclical economic risks.

Delivering Generous Income

Today, a broadly diversified bond portfolio can potentially generate sufficient income that compounds above the expected rate of inflation and compensates for the possibility of an uptick in credit risk. For example, the average yield of U.S. Treasury notes and bonds currently stands around 4.35%. The spot level of inflation (as measured by the Personal Consumption Expenditures [PCE] Index) currently stands just above 4%, and longer-term implied rates of inflation are hovering near 2.5%. As a result, U.S. Treasuries offer a positive real yield that many investors are likely to find attractive over time.



Investors willing to go down the rating spectrum and/or into global bond markets will find real yields even higher.

Buffering Against Volatility

In 2022, the marked increase in price volatility unnerved many bond investors as inflation surged and prices plunged. Tightening monetary policy in the U.S. and other countries and lack of clear forward guidance from policymakers drove materially higher interest rate volatility and yields.



While an “uncertainty premium” is certainly warranted given the long list of risks facing investors, base rates in many countries are above the level of spot inflation, banks' lending standards are tightening, and financial liquidity continues to drain from the system.

Diversifying

Bonds are a good hedge against slower economic growth and/or a recession, but they are not a good hedge against inflation. However, as inflation pressures have started subsiding, bond prices have begun diverging from the prices of more cyclically exposed financial assets—namely, equities.



To be fair, inflation remains a dominant factor in today's market. Looking ahead, though, we expect bond prices to continue diverging from more growth-sensitive assets as inflation pressures subside and growth pressures emerge.

Riding the curve

To capitalize on these trends, here are five ideas for bond investors:

Extending duration: Consider extending along the yield curve and adding duration as yields rise.
Maximizing yield: Short- duration, lower-quality securities could help boost a fixed income portfolio's overall yield without adding significant interest rate risk.
Moving up in quality: In our view, issuers with strong cash flow, diversified sources of funding, and a low percentage of variable-rate debt are well poised to thrive in today's economic environment.
Adding munis for stability: In an environment of slowing economic growth and potential recession, general obligation bonds have generally outperformed revenue sectors.
Going global: Global bond markets have started diverging from one another after the initial inflation shock of 2021/22, offering a good opportunity to diversify interest rate exposure and position in countries/regions with tight monetary policy and falling inflation.

Glad to be back

Bonds are continuing to do exactly what they are supposed to: generating income, buffering volatility, and hedging cyclical risks. It's time for them to again become a portfolio's cornerstone investment.

About the Author: George Bory, CFA is the chief investment strategist for Fixed Income at Allspring Global Investments. In this role, he is responsible for partnering across the fixed income platform to help each team set investment strategies for our full range of products and collaborating with clients to identify appropriate investment strategies. In addition, he leads the Fixed Income team of portfolio specialists and serves as a portfolio specialist for the Global High Yield team. Prior to this, he served as head of fixed income research for Wells Fargo Securities and earlier served as the head of credit strategy. George began his investment industry career in 1992. He earned a bachelor's degree in economics from Siena College and completed the London School of Economics' General Course.

Disclosures: CFA® and Chartered Financial Analyst® are trademarks owned by CFA Institute.

Material is for informational purposes only and professional, institutional or qualified investors. No retail use outside the U.S.

MATERIAL DOESN'T CONSTITUTE AN OFFER/SOLICITATION, NOT INTENDED TO BE USED IN JURISDICTION OR WITH PERSON WHERE WOULD BE UNLAWFUL.

Allspring Global InvestmentsTM is the trade name for the asset management companies of Allspring Global Investments Holdings, LLC, a holding company indirectly owned by certain private funds of GTCR LLC and Reverence Capital Partners, L.P. Unless otherwise stated, Allspring is the source of all data, current or as of date stated; past performance not a guarantee of future results; all investments contain risk; content for informational purposes with no representation regarding adequacy, accuracy or completeness.  Opinions/estimates aren't necessarily that of Allspring, are subject to change. This communication doesn't contain investment advice, recommendations or research, as defined under local jurisdiction regulation.

ALL-09252023-kyyqsnr4