Tilting Away from Traditional Fixed Income

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Sam Lau

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Samuel Lau, DoubleLine Capital, portfolio manager.

So, the current environment that we are in is a difficult one, and that’s a low-yielding fixed-income environment. So, while it’s difficult for fixed-income investors, what makes it even more challenging is the fact that we are not only in a low-yielding world, but we’re also in one where at DoubleLine we’re projecting a trend of higher rates. So, that’s kind of where we’re at today.

We all know that bond prices and interest rates move inversely to one another. So, when we start off with a lower yield, you have less income to protect your portfolio from changes in interest rates.

So, we think that the key to navigating the fixed-income market for the remainder of 2021 and likely beyond will be properly managing your interest-rate risk within your bond portfolio.

Now, with that said, we do have tailwinds in the fixed-income market. Beyond just struggling with the low yields, we do have a recovering economic environment, which is generally supportive of credit.

So, in this environment I favour sectors with minimal rate risk that can still provide attractive income. So, my preference today is for areas of non-traditional credit. And these are areas that you can still find relatively attractive yields, and in some cases you can still find yields above 4% while still remaining investment-grade rated.

And by non-traditional sectors, I’ll qualify that by saying that I mean those sectors that aren’t found within the Barclays Aggregate. So, the ones that aren’t Treasuries, the ones that aren’t sovereign bonds, the ones that aren’t agency-mortgage-backed-securities and the ones that are not investment-grade corporate credit. So, all the other areas are the ones that I’m referring to as non-traditional assets. And those are the assets in fixed income that are harder to access for the average investor, and in many cases even it’s hard to access for the professional investors to source as well.

So, some of these areas are what we refer to as securitized or structured credit. If you think about non-agency residential mortgage-backed securities, commercial mortgage-backed securities. Areas of asset-backed securities are a little bit more esoteric, so not your traditional credit card ABS or a car ABS but some of the other things that might be backed by infrastructure type assets or transportation type assets — things that are a little bit more difficult and less trafficked again for the common investor.

And then finally within that securitized structured credit cohort, we also like CLOs or collateralized loan obligations. And part of the reason why we like this is the yield-to-duration profiles in these sectors are relatively attractive. Taking a step back to define the yield-to-duration as a metric we look at, at DoubleLine — that indicates how much income you receive relative to how much interest-rate risk you take on. So, the higher the ratio, the better when thinking about rate risk.

Keep in mind that you do need to be mindful of the credit risk that these assets bring. And in markets where many of the industries have run up significantly in price, you need to be able to shake out those mispriced assets that still have good value in them and separate those from the ones that are grossly overpriced.

On top of that, we do think it’s OK to own a little bit of high yield and bank loans in a well-diversified portfolio, as well as other areas of below investment-grade credit, again, with the right security selection and team managing the portfolio.

But there’s also other areas that are outside of the U.S. — parts of the EM world, you’re also seeing attractive yields in the EM sovereign market.

So, if your primary objective is to generate income and you’re able to hold on to your fixed-income positions without getting nervous and selling at the wrong time, then I would lean to portfolios and managers that have experience in running diversified portfolios that do include these non-traditional assets. That way, you can pick up some income; you can also manage your interest-rate risk, as most of these credit-sensitive sectors of the market do have less interest-rate risk and should do better in a rising-rate environment, all else equal.