Strategies for Fixed Income Investors as Rates Rise

From

Related Article

Text transcript

Ebad Saif, fixed-income client portfolio manager for CIBC Asset Management.

In the current rising interest rate environment, fixed-income investors can find protection through a few different investment strategies. The first investment strategy can be to invest in bonds with lower duration. These bonds experience lower drawdown when interest rates rise. Investment strategies that have less than five-year bond duration are considered short-term bond strategies, and are very attractive in protecting from a rising interest rate. Especially when considering parts of the yield curve offering the greatest value.

The yield curve today is quite flat, and with some parts of the curve actually inverted. For investors, a flat yield curve means they can get a similar yield on a three-year bond and a 10-year bond, so there isn’t the usual term premium where investors are compensated more for taking on more interest rate risk. This makes short-duration bonds fairly attractive, as the yield curve is relatively flat, we’re finding good value in bonds in the two- to six-year range. Another place where we’re seeing attractive value is also in the new issue market, which is providing some opportunity as new bonds are being offered at discounts. So there is opportunity to also purchase new issued bonds that are of higher quality and are being offered at very attractive prices.

The second fixed-income strategy that investors have available to them for protection in a rising interest rate environment is to hold floating rate debt. These securities have coupons which reset periodically and avoid the negative impact of bond values from a rising interest rate. There’s a few different types of floating rate debt strategies that are available for clients in the marketplace. The first one can be to invest in an investment grade floating rate bond strategy, which focuses primarily on high quality corporate bond debt, and those kinds of strategies are currently yielding in the 4.5% range. Quite attractive for high quality floating rate corporate bond strategies.

The second type of investment opportunities available for clients can be floating-rate debt that invests in high yield bonds and floating rate loans. These are below investment grade credit rating securities, and these strategies therefore offer a significantly higher yield. Currently, it could be in the 9.5% range, but this does come with additional credit risk. For investors willing to look through short-term noise, locking in close to 9.5% yields for a below investment grade loan strategy is a great investment opportunity. The elevated yield also provides some buffer in case credit spreads widen in times of market stress. So for investors that have a long-term horizon, this can be a good time to start allocating to this particular type of strategy.

The last point I want to discuss was although the primary concern for investors today is protection from rising rates, as central banks near the end of their rate hiking cycle, the opportunity to put cash to work and lock in these elevated yields fixed income is offering can be a short-lived opportunity. The market’s already pricing in rate cuts in the second half of 2023, so investors should start thinking about putting capital to work before their current opportunity is unavailable.