We’re providing financial advisors with talking points and potential solutions for fixed-income clients who are in search of yield.
Todd Crawley: We’re continuing the conversation around our fixed-income narrative: Risks worth worrying about, with talking points and solutions for taking on yield. I’m Todd Crawley, and this is The Essential Practice podcast.
For a healthier perspective on the Fed, listen to part 1 of this short series, episode 413, wherever you subscribe to this program. And access to our full thought leadership narrative is just a call away to your regional director.
But another “risk worth worrying about” is around yield and how to take on yield in this environment. Joining us once again is Danny Sarnowski, portfolio specialist with Wells Fargo Asset Management’s global fixed-income platform. Danny, welcome.
Danny Sarnowski: Thanks for having me, Todd
Todd: Anytime. Let’s start by understanding why we’re “judiciously” taking on yield. And I put that word in quotations—judiciously taking on yield.
Danny: Yeah, sure. Well I’m sure as many of the listeners are aware, our current equity bull market just became the longest in history, taking us further into a years-long expansion. And fundamentals suggest that there’s room left in this cycle, but many investors believe that we’re in the later stages. So, depending on whatever metaphor you use—this cycle’s either late in the game, going into overtime, or about to hit extra innings.
So if you feel this cycle’s a little bit long in the tooth, it can be helpful to consider the amount of risk investors are taking in their portfolios, especially in their fixed-income allocations, where most investors look for relative safety during risk-off periods.
Todd: Yeah Danny, we’ve seen, if you rewind the clock back five years, in this super low-interest rate environment that we’ve been living through, you know, retired people who are living on fixed income are having to get their income in other ways than just clipping a coupon out of fixed income, because the rates have been so low. And so they may have been sort of reaching for that extra bit of income through instruments that probably carry on more risk than normally they would be willing to take. And so we’re having that conversation, or trying to have that conversation, out here in the field about: what are your sources of income, and in an upward-rising interest rate environment that we seem to be finally arriving at, how do you rebalance your portfolio back? So that’s a great talking point.
Danny: Yeah, I totally agree. We’ve definitely seen investors reach for yield through that low-yield environment.
Todd: Yeah. But I know you’ve got a few talking points about what risks they should be worried about in their portfolio. Why don’t you go over those with us?
Danny: Absolutely. One thing we’d want investors to consider when it comes to fixed income is that staying invested in fixed income, even through more difficult periods, is really important because the bond story is an income story. In fact, if you took a hypothetical portfolio made up of 75% of the Bloomberg Barclays U.S. Aggregate Bond Index and 25% of the Bloomberg Barclays U.S. High-Yield Index, that portfolio over the last 20 years returned about 194% accumulative return. But if you take that and break it into the coupon return and the price return, the price return over that 20-year period is actually -2%. So the income is the entirety of the return. So if clients are worried about risk, staying invested really is important to give that portfolio time to earn that income and build that total return for them over the long haul.
Todd: Let’s talk about some of the solutions.
Danny: Yeah, again, from a solutions standpoint, we think, first and foremost, it’s staying invested. It’s giving that portfolio that opportunity to earn income. But certainly shortening duration or using managers or solutions that have either more duration flexibility available to them, or adding short duration to the portfolio to pull back and limit some of the interest rate risk exposure in the portfolio can be helpful. As well as moving up in credit quality. And again, that doesn’t mean moving all the way, let’s say to treasuries, where there’s little to no credit risk. It just means, again, if you’re investing in high yield for example, maybe pulling back some of the CCC exposure moving up and taking a slightly higher position in BB and B paper. And then definitely we want to encourage advisors and clients to look to high-quality, inefficient markets like municipals so they can be sourcing opportunities to still earn income without having to stretch for yield either through longer duration or lower credits.
Todd: Yeah, you’ve given us some great talking points. So let me see if I can summarize this, and jump in and correct me because I’m sure I’ll be wrong. You’re saying, overall on your fixed income portfolio, now would be a good time to review that portfolio for the risks that you may not want going forward—served us well the last five years in a super low-rate environment, but in a rate environment that’s moving higher, reassess that landscape and see where your hidden risks are and try to address that. Doing that, we want to be higher quality, lower duration, and move closer to that shorter end of the curve. Have I got that about right?
Danny: Yeah, sure.
Todd: Well Danny, let’s wrap this conversation up here. Happy that you could shed more light on these fixed-income narratives of ours. It is a big topic out there that our clients, the advisors, are faced with. So thank you for sharing your thoughts.
Danny: Well it’s my pleasure Todd.
Todd: Until next time, I’m Todd Crawley. Thank you for listening to The Essential Practice podcast.