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Don’t Wait for Goldilocks: Riding the Curve in Fixed Income

By: Janet Rilling, CFA, Daniel Sarnowski, and George Bory, CFA, Allspring Global Investments
The Fixed Income team at Allspring Global Investments highlights the importance of adding duration while there is still an opportunity to “ride the curve” and enhance the ballast of a fixed income portfolio to position for different economic environments.
Don’t Wait for Goldilocks: Riding the Curve in Fixed Income
This is an excerpt from NCPERS Winter 2024 issue of PERSist, originally published January 16, 2024.
Key Takeaways:
  • Prepare for different outcomes. Fixed income markets remain unsettled. Taking a measured approach to allocating across the yield curve, or "Riding the Curve,” may help investors enhance the ballast of their portfolios and position for different economic environments and outcomes.
  • Diversify duration exposures. Yield curves have steepened recently, bringing longer-maturity yields more in line with those found on the front end of the curve--offering an attractive entry point for adding duration across the yield curve.
  • Don't wait. The opportunity cost for investors waiting for a "Goldilocks moment" to add duration has risen of late. In prior periods, those who waited to increase duration significantly underperformed those who diversified.
Preparing for a range of outcomes
Investors face a highly uncertain future. We believe this requires preparation for a range of outcomes rather than placing a single "bet" on a shift to a specific set of conditions. We see value in adding a broad mix of duration exposure, or "Riding the Curve" to prepare for a wide range of possible outcomes at this point in the economic cycle. Creating a more diversified portfolio ballast through adding duration in small increments along the yield curve may offer a better approach than solely targeting the long end of the curve.
Yields are currently at multiple-year highs across the yield curve. For example, yields at the front end of the yield curve are at their highest point in over 20 years. Nearly every spot along the curve is at the highest point in more than 15 years and well above its 15-year average (Exhibit 1). This higher level of income forms the basis for the total returns bond portfolios may generate over the coming years and may leave bond investors in a more advantageous position than nearly any time since the Global Financial Crisis.

Exhibit 1: Riding the Curve Offers Several Advantages

By diversifying exposures across the yield curve, investors can position for different economic outcomes. If yields decline and the yield curve normalizes, then bond prices would rise, helping boost total returns. However, if bond yields were to rise, then current yields would likely provide a significant "volatility cushion" against lower bond prices (Exhibit 2).
Exhibit 2: Current Yields Provide a Generous Buffer Against Future Volatility

The falling opportunity cost of diversifying across a steepened yield curve

Making a significant shift in portfolio duration at the optimal time can be very difficult, and making such a move during a period of economic stress can be even more challenging. Allocating across duration exposures may offer a better approach where there can be diversification and return benefits as the curve normalizes.
It may also help reduce the inertia that can lead to suboptimal investment returns. As yield curves have steepened recently, longer-maturity yields are now more in line with those found on the front end of the curve. This has reduced the relative yield cost investors may be willing to give up to diversify their duration exposures (Exhibit 3), creating a potentially compelling entry point. Curve steepening has also occurred in the municipal bond market, offering investors the opportunity to capture the highest tax-exempt yields since 2009.

Exhibit 3: Lower Cost of Diversification

The rising opportunity cost of waiting for Goldilocks
Attempting to time the market is always difficult, and the inflection points that offer the optimal catalyst for change are often best identified in the rearview mirror. In prior periods of monetary policy transition, investors who waited for a "Goldilocks moment" to make a substantial shift in their duration positioning incurred significant opportunity costs and realized returns approximately 58% lower on average than those with a diversified duration portfolio during the period of transition (Exhibit 4). Data also shows that industry-wide money market fund (MMF) assets continued to climb during these periods even as the Federal Reserve (Fed) cut rates (Exhibit 4).

Exhibit 4: Returns During Transitionary Periods in Monetary Policy

Potential benefits of "Riding the Curve"
Preparing your portfolio for a broader range of outcomes. A "soft landing" scenario has become more widely accepted by investors throughout 2023, but history tells us that monetary policy cycles often meet a more abrupt end and the benefit of being prepared ahead of time for bond investors can be significant.
Diversifying your exposures. By staking positions across the yield curve, investors can diversify their portfolio and may increase the number of environments in which the portfolio can thrive.
Increasing the volatility buffer afforded through positive real yields. Yield and credit spread volatility may persist as the impact of higher rates flows through the economy. Yield breakeven points are high across the curve, affording investors the biggest cushion for volatility in more than 15 years.
About the Authors:
Janet Rilling, CFA, is a senior portfolio manager and the head of the Plus Fixed Income team at Allspring Global Investments. In this capacity, she has oversight and portfolio management responsibilities for separate accounts, mutual funds, and commingled vehicles across a range of strategies. Janet joined Allspring from its predecessor firm, Wells Fargo Asset Management (WFAM). She joined WFAM from Strong Capital Management. Prior to joining WFAM, she was a high-yield and investment-grade credit research analyst and a portfolio manager. Janet began her investment industry career in 1990 as an auditor with Coopers & Lybrand, specializing in the manufacturing and financial services industries.
Daniel (Danny) Sarnowski is a portfolio specialist for the Plus Fixed Income team at Allspring Global Investments. In this role, he serves as the primary investment contact on accounts and works closely with portfolio managers and sales team members. He joined Allspring from its predecessor firm, Wells Fargo Asset Management (WFAM). Prior to his current role, Danny served as a key accounts manager for WFAM's Liquidity Solutions team. He was responsible for the distribution of institutional money market funds and ultra-short-term fixed income funds. Previous roles include managing sales and service teams within the retail intermediary and former direct-to-fund businesses for Wells Fargo Funds Distributor, LLC, and serving as a preferred client specialist at Strong Capital Management.
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. George joined Allspring from its predecessor firm, Wells Fargo Asset Management (WFAM). Prior to joining WFAM, he served as head of fixed income research for Wells Fargo Securities and earlier served as the head of credit strategy. Before that, George was the global head of credit strategy for UBS Securities. Previous roles include working for J.P. Morgan Investment Management, where George held several positions, including senior global credit portfolio manager.

CFA® and Chartered Financial Analyst® are trademarks owned by CFA Institute. Copyright 2023. ICE Data Indices, LLC. All rights reserved.
This material is provided for informational purposes only and is for professional, institutional, or qualified clients/investors. Not for retail use outside the U.S.
Allspring Global Investments" (Allspring) 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 (which is current or as of the date stated); past performance is not a guarantee or reliable indicator of future results; all investments contain risk; content is provided for informational purposes only with no representation regarding its adequacy, accuracy, or completeness and should not be relied upon; views, opinions, assumptions, or estimates are not necessarily that of Allspring and are subject to change without notice; and this communication does not contain investment advice, an investment recommendation, or investment research, as defined under local regulation of the respective jurisdiction.
©2023 Allspring Global Investments Holdings, LLC. All rights reserved.



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