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Notes from the Desk – Focusing on the Three C’s for Fixed Income Investing


by Rob Williams, Sage Advisory Director of Research

Fixed income investors have benefited from falling rates and a recovery in spreads, which has generated attractive returns thus far in 2020. As we approach the end of this unexpected year, a more prudent and active approach is necessary as the backdrop has become more challenging – valuations are less compelling; yields are low and are expected to remain so; and, as illustrated in the chart below, the duration (or interest rate sensitivity) of fixed income indices is high for the slim cushion of yield they provide.

Aggregate Bond Index – Interest Rate Risk vs. Yield

Source: Bloomberg, 11/16/20

As active fixed income managers, we are focused on three C’s – curve management, (yield) carry, and the consumer-led recovery.

  1. Curve Management – While the economic recovery and increasing Treasury issuance have kept upward pressure on longer rates, the unknown size and scope of a fiscal package and the notion that the Fed may target specific segments of the curve add enormous uncertainty to the direction and degree of curve movement.

Shifting Curve Segment Returns

Source: Bloomberg, 11/16/20

  1. (Yield) Carry – Interest rates have less room to fall and spreads have less room to tighten, making yield difficult to come by. While spreads are not as attractive as they were earlier in 2020, we continue to see a positive tone for spread sectors, as long-term valuations are near average levels and have the support of Fed policy and a strengthening economic picture.

Investment Grade Spreads

Source: Bloomberg, 11/16/20

  1. Consumer-Led Recovery – The consumer is the biggest part of the economy, and the consumer continues to recover, which is supported by trends data from housing, retail sales, the savings rate, and consumer confidence indicators. A focus should be on areas that are tied to and will benefit from a continued consumer-led recovery, including cyclicals and REITs, increased exposure to higher-yielding markets (BBBs); and select names in such sectors as energy and basic materials that offer attractive yield pick-up.

Real GDP Growth – Q/Q % Change, Annual Rate

Source: Bloomberg, 11/13/20

 

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