Drew O’Neil discusses fixed income market conditions and offers insight for bond investors.
In the active-management world that most market commentary comes from, the focus is often on trying to do something to outperform the market. Through the lens of a portfolio manager, the “market” is typically whatever index they have chosen to benchmark themselves to. In the fixed-income space, an attempt to outperform the market can be done by actively trading while doing things such as overweighting or underweighting specific sectors or products, extending or shortening duration, or just simply trying to time the market (buying low, selling high). These trades and portfolio positioning are done based on some prediction as to what is going to happen in the future. If their guesses are correct, maybe they outperform. If they’re wrong, they underperform. If the market falls by 10% and your portfolio falls by just 8%, you “outperformed.” For the total return portion of your portfolio, you might consider this a victory. For the principal protection portion of your portfolio, this is not likely what you had in mind.
Are these the games you want to play with the portion of your portfolio intended to protect your hard-earned principal? For many investors, the answer is “No.” When it comes to the total return portion of your allocation, attempting to outperform might make sense. For the principal protection portion, simply “performing” might be enough. With a passive, buy-and-hold strategy in fixed income, yields are locked in from the day you purchase a bond until the day the bond is redeemed (barring a default and assuming you do not sell prior to redemption). Your portfolio will perform exactly as expected, regardless of what “the market” does. No outperformance, no underperformance, just performance.
Luckily, the current market is offering yields that are more attractive than at most points over the past 15 years. The returns that can be locked in right now are enticing enough that many investors are realizing that they might not need to reach for outperformance. The chart below shows a range of hypothetical portfolios to provide some context into the yields that can be locked in today. With investment-grade portfolios providing annual returns well north of 5%, risking underperformance while reaching for outperformance might not make sense for the portion of your portfolio intended to preserve principal.