This piece uses five charts from the Guide to the Markets to explain why, despite an uncertain economic backdrop and recent volatility, we still see compelling opportunities across the fixed income landscape.
Fixed income has historically provided two key characteristics in a multi-asset portfolio:
- A steady stream of income.
- Diversification against riskier assets if the growth outlook deteriorates.
In the decade following the global financial crisis the ability of bonds to offer either of these elements had steadily diminished. A long bull market compressed yields to record low levels, forcing investors to make an unenviable choice: accept paltry returns by investing in government bonds at ever lower yields, or chase higher yields in lower quality parts of the fixed income universe and take on much more risk as a result.
The declines witnessed in fixed income markets in 2022 were unprecedented. As yields normalised, the global aggregate bond index fell by 16%, the worst annual decline since the index began in 1990 and more than three times as bad as the second worst year on record. While uncertainty about the direction of US trade and fiscal policy means markets are likely to remain volatile for some time, we believe that the fixed income reset is now broadly complete and that the role of bonds in a balanced portfolio has been restored.
Bonds once again offer an attractive income stream to investors. Sticky inflation means that absent a shock to growth, yields are unlikely to fall significantly. This means income is likely to form the bulk of investor returns and portfolios should be positioned to capture it. However, with US policy leading to elevated uncertainty higher starting yields should also give investors comfort that bonds are better positioned if risks materialise to either the up or downside. If tariffs reignite inflationary pressures bonds have a greater cushion to absorb further upward pressure on yields before investors lose money over a 12-month period. However, if recession worries come to the fore yields have more room to fall than they did in 2020.