(June 27, 2012) — With yields on high-quality bonds yielding low interest, it’s hard to find income in fixed-income, says Lori Whiting, investment director at Wallington Management.
“One solution is a diversified multisector credit portfolio, with a focus on higher-yielding credit sectors and securities whose mix shifts with changes in market conditions,” she advises in a newly released whitepaper. She notes that this approach to credit can help meet the desire for income while retaining the downside protection a fixed-income portfolio can provide.
According to Whiting, across credit sectors, some of the best opportunities for investors are in high yield, bank loans, and non-agency residential mortgage-backed securities (RMBS).
Nevertheless, exploiting the income and return potential of credit sectors does not come without risk. “By definition, investment in these sectors entails credit risk; a significant portion of the opportunity set is rated below investment grade. Furthermore, securities in these sectors are often callable, so the higher income and yields they offer could be cut short if falling yields lead obligors to buy back their high-coupon debt,” the paper asserts.
The low yield among bonds is a familiar story. Last year, research by the London Business School and Credit Suisse noted that bond investors should expect less robust returns in the future. London Business School’s Elroy Dimson commented: “We are struck by the volatility of the size, value and momentum effects. Over the long term, all three factors have provided a positive risk premium. But over shorter intervals, these premia can easily go into reverse.”
The authors of Credit Suisse’s report found that bond investors should not expect returns for the next 11 years to be as strong as those of the previous 11 years, largely as a result of rising inflation. While bonds in 19 developed markets worldwide outperformed stocks in the 11-year period ending December 21, 2010 by an average annualized 3.2 percentage points, the outperformance of stocks over bonds in the same countries has been by 3.8 percentage points since 1900.