This special edition features a discussion about the fixed-income markets ahead of the election and how bond investors can source income in today’s low-yield environment. With front-end interest rates again in ultra-low territory and longer-term bond yields hitting fresh lows around the world, investors are seeking yield, and the question is where to find it.
To help answer, George Bory, Managing Director and Head of Fixed Income Strategy and Product Specialists at Wells Fargo Asset Management (WFAM), and Janet Rilling, Senior Portfolio Manager, Head of Multi Sector – Plus & High Yield, WFAM Global Fixed Income, discuss the opportunities and risks they see for investors.
George Bory: I’m George Bory, and welcome to a special edition of On the Trading Desk®.
Today’s topic is a focused discussion on finding income in today’s world of ultra-low interest rates. It’s a timely conversation, given many investors around the world are yield-starved and looking for ideas.
I’m joined by Janet Rilling, Senior Portfolio Manager and head of the Wells Fargo Asset Management Multi Sector Fixed Income – Plus & High Yield team. She joins us today to share her insights. Thanks for being here, Janet.
Janet Rilling: Hi, George. Happy to be here.
George: Janet, 2020 has seen a tremendous amount of volatility across the capital markets, including the bond market. Can you share your thoughts on what we’ve seen so far this year?
Janet: Well, it’s been quite a year. Essentially, we’ve experienced a full cycle in just the first 9 months of 2020. Early in the year saw the end of the longest bull market on record. We’ve experienced tremendous volatility prompted by the liquidity crisis in March as the pandemic reached critical mass here in the U.S. This was followed by a stream of economic data hitting multi-generational bad levels—record unemployment, deep drop in GDP [Gross Domestic Product], and so on.
As we look to the recovery, our team has expecting what we refer to as a “dog leg” recovery. That’s where we see a very sharp initial period of improvement, followed by a period of slower economic expansion, which results in a shallow, more difficult period of recovery.
We think that we’re in the middle of the dog leg now. We’ve made up a lot of ground since the onset of the recession, but looking out, we see continued improvement getting harder from here.
George: And how has that volatility impacted bond yields?
Janet: In a word, it has driven yields lower. Front end yields fell early in the year as the U.S. Federal Reserve lowered the Federal Funds rate back to near zero.
At the same time, further out the curve and in the risk markets, yields initially blew higher as credit spreads widened in a risk-off move.
Since peaking in March, yields for most spread sectors, which includes investment-grade credit, securitized products, and high-yield bonds, have narrowed substantially. This narrowing of spreads, coupled with dramatically lower Treasury yields, has left all-in yields at very low levels.
George: So this is not just a domestic U.S. issue. It sounds like it’s a global phenomenon, as well.
Janet: It is. In fact, if you look at the Bloomberg Barclays Global Aggregate Bond Index, a proxy for all the investment grade debt around the world, two out of every three dollars was yielding less than 1% at the end of September. And for the first time, more of that global debt had a negative yield.
Looking at it another way, more debt was yielding less than 0% than was yielding over 2%.
George: Haven’t investors been seeing low yields for quite some time? What’s different today than what we’ve seen in the past?
Janet: Yes, globally we’ve seen low yields as a persistent problem for several years in developed markets, and the amount of negatively yielding debt has been steadily rising.
European investors, for example, have had to grapple with low yields for quite a while, and Japanese fixed-income investors for even longer.
What’s different now is that U.S. investors are being faced with exceptionally low yields. Just two years ago, in September 2018, 100% of the Bloomberg Barclays U.S. Aggregate Bond Index had a yield greater than 2%. As of September 30 of this year, only 16% of the index had a yield greater than 2%.
George: So what’s the impact of that change?
Janet: The impact is that investors whose holdings are concentrated in the U.S., like those invested in U.S. dollar investment-grade fixed income, are likely to see very low yields for the foreseeable future. The supply of yield is at an all-time low in the U.S.—and around the world—and demand is likely to continue to rise.
That mismatch means the low-yield problem is likely to persist and perhaps get worse.
George: Then what can investors do about it?
Janet: They can take a somewhat broader view. By opening oneself up to positions beyond the U.S., beyond the U.S. dollar, or beyond investment-grade credit, we see attractive opportunities to source income.
Further, in our view, the real opportunity is not just to allocate a static position to some of the sectors, like U.S. high-yield or emerging market debt. We see the best strategy as one where investors tactically shift allocations to exploit the best relative values.
George: So it sounds like there’s no easy “set it and forget it” option for yield-seeking investors. It sounds like they need more active management, not less.
Janet: An easy option for investors is to partner with an asset manager or a financial advisor who has the capabilities to make the sort of decisions I just described.
We believe we can manage a foundational fixed-income portfolio, one that works and acts like the broader U.S. investment grade market, but also structure it in a way that finds opportunity to outperform the Bloomberg Barclays U.S. Aggregate Bond Index. We do that by using diversified sources of income, making many small decisions using a broad set of market exposures, and by consistently focusing on a shorter time horizon. It takes work and discipline to do this, but we believe it can be an effective strategy for sourcing income in today’s markets.
George: And let me ask you, with the time we have left, do you have any parting thoughts you’d like to leave with our listeners?
Janet: So I would sum up by saying that there’s a growing recognition that low yields globally is a challenge for fixed-income investors. But it is good to keep in mind that an allocation to the fixed-income asset class, even at current yields, can play an important role in an investor’s portfolio by acting as a balance for when market volatility rises.
Further, by constructing a fixed-income portfolio that sources income from a variety of places—and does it tactically—means an investor can still receive benefits from the fixed-income portion of their portfolio.
George: Thank you, Janet, for sharing your insights.
Janet: Thanks, George. Nice speaking with you.
George: For our listeners, if you’d like to read more market insights and investment perspectives from the fixed-income teams at WFAM, you can find them at http://on.wf.com/6128GCCOO. To stay connected to On the Trading Desk, and be able to listen to past and upcoming episodes of the program, you can subscribe to the podcast on iTunes, Stitcher, or Overcast. Until next time, I’m George Bory. Thanks for listening.
Diversification does not ensure or guarantee better performance and cannot eliminate the risk of investment losses.
All investing involves risks, including the possible loss of principal. There can be no assurance that any investment strategy will be successful. Investments fluctuate with changes in market and economic conditions and in different environments due to numerous factors, some of which may be unpredictable. Each asset class has its own risk and return characteristics.