At a crossroads as rates rise? Here’s what a bond indicator is telling us
Rising government bond yields have presented more room to manage the impact of rate hikes. How big is this leeway?
#yield #quality #income
As the global economy loses momentum and market volatility persists, some income investors face a tough choice. They may be thinking of positioning towards traditional government bonds which could help manage volatility but present relatively low yield for the overall portfolio. Others may be considering non-traditional sectors that could offer higher income opportunities but with more risk.
What are our considerations when it comes to quality, income and risk in an overall bond portfolio?
Quality and yield both matter to us
We believe we can tap into relatively attractive income and risk-adjusted return potential by investing flexibly across different sectors in the bond markets. Non-traditional income sources such as securitised debt1 is one of the asset classes in our search for quality and yield opportunities in an overall bond portfolio2.
Agency mortgage-backed securities (MBS) are guaranteed by US government-related bodies, such as Ginnie Mae, Fannie Mae and Freddie Mac, and they are generally AAA-rated. MBS pooled from commercial mortgage loans are called commercial mortgage-backed securities (CMBS).
As illustrated below, agency MBS and CMBS have exhibited relatively similar trends of volatility as US Treasuries over the 10-year period between 1 September 2012 and 31 August 2022.
Volatility trends of US Treasuries, agency MBS and CMBS over the past 10 years
Since the beginning of 2022, we see compelling opportunities in these securitised assets. While positioning our overall fixed income portfolio currently, agency MBS and CMBS play a defensive role as they present income opportunities that are relatively higher than US Treasuries. Currently, we prefer higher coupon agency MBS because of the advantage of elevated yields, while also improving the overall quality of our securitised asset allocation. We also favour multi-family CMBS because of supportive long-term demographic trends while short-term leases can also allow these properties to increase rents and cash-flows as inflation stays elevated.
Active management, which integrates macro views and the bottom-up, yield-focused insights of asset class specialists, is crucial when considering quality, yield and risk in an income portfolio. We employ a flexible approach to differentiate and invest where opportunities can be found as market conditions evolve, alongside robust credit selection and a focus on quality.