Second Quarter 2014 – “The Waiting is the Hardest Part”
For more than five years institutional investors have evaluated (and re-evaluated) the role of fixed income in their portfolios. During the financial crisis of 2008, a flight to quality led many investors to government debt, sending Treasury rates lower and credit spreads to historically wide levels. Near the end of the market downturn, opportunistic investors shifted to a more credit-oriented approach in an effort to capitalize on much higher yields and the potential for strong mark-to-market gains if spreads contracted. In recent years many investors, under the premise that an end to the low-rate cycle is approaching, added floating rate debt (bank loans) to portfolios in an effort to mitigate their losses when interest rates rise.
Despite the closely related complexity of the economic climate and bond pricing over this time, we have now reached a particularly challenging period for asset allocators as the threat of higher interest rates, in addition to the historically low coupon offered by many fixed income instruments, have led investors to reevaluate how they view bonds within their portfolios.
Importantly, while the prospects for fixed income as an asset class may look bleak in the coming years, we hold steadfastly to the notion that it has a place in strategic allocations although we fully acknowledge that there are no simple solutions or particularly compelling ways to address appropriate, albeit widely held, concerns. At the same time, we are struck by some of the misconceptions regarding fixed income risk both in absolute terms and relative to other asset classes.