How can investors navigate the world of fixed income when the U.S. Federal Reserve raises interest rates, central banks unwind their balance sheets, liquidity is tightened and the futures markets debate inflation expectations?
These were just a few of the questions that experts at Inside ETFs in Florida debated today. Below is a summary of their key points.
1) Don’t avoid duration
Many investors piled into short-dated bonds, which are less sensitive to interest rate movements, in 2014 as they tried to second-guess the movements of central banks and protect their investments. However, central banks did not hike rates and investors missed out on the longer end of the curve.
Matthew Tucker, head of iShares fixed income strategy, said duration equals diversification, and all investors should have a sample of longer-dated bonds in their portfolio.
“People get too caught up about the curve steepening or flattening,” he said. “Investors sure wish they had it [long-dated bonds] last year. If this is a 10 to 15 year portfolio, you want duration in there.”
2) Don’t have a static asset allocation
Investors are living through an era of unconventional monetary policy, therefore it is not a good idea to leave your asset allocation unchanged for long.
Jerome Schneider, managing director head of PIMCO's short-term and funding desk at PIMCO, said there is a downward pressure on global yields and investors can’t ignore it.
“Investors have had warm air blowing in their faces for many years now, especially in the U.S., and there will now be a course of recalibration: it could be at the short end or long end of the curve,” he said. “Interest rate exposure will have to be recalibrated pretty actively in this regard and don’t expect the smooth ride we’ve had over the last four years.”
Schneider said this potential cycle of tightening monetary policy in the U.S., and the loosening policy in Europe, is the most significant we have seen throughout history.
“What’s most dangerous is staring into a static allocation in the face of changing policy and demand technicals changing,” he said. “In terms of thinking about your fixed income allocations, it’s about how you adapt to that in the short and medium term.”