However, this year is shaping up to be a decidedly different story. We believe last year’s interest-rate moves and asset-price declines have spawned a potentially compelling investment opportunity set for risk-conscious fixed income market participants. The early 2023 market rally notwithstanding, we expect multiple good price entry points (along with some volatility) to show up over the rest of the year.
Now is not the time to give up on fixed income
Rising stock/bond correlations in 2021 and 2022 seemingly left no place for investors to hide from market volatility. So, are frustrated investors to conclude that fixed income has lost some of its proven ability to defend principal and diversify other portfolio risks? We don’t think so. Despite fixed income’s prolonged slump through 2022, we remain confident in the power of this cornerstone asset class to retain its key role as a portfolio diversifier and equity downside mitigator in risk-off market environments.
Clearly, that was not so last year — a striking anomaly, in our view. Fixed income exposure in the form of interest-rate duration typically acts as a counterweight to other risks in investor portfolios. For example, periods of risk aversion that tend to negatively impact risk assets such as equities have historically often seen bond prices rise. In 2022, however, aggressive global central bank monetary policy tightening pushed yields up across the yield curve in most developed markets.2 The result: Bond prices fell along with equity values, with yields across many high-grade fixed income sectors reaching their highest levels since the early stages of the 2008 – 2009 global financial crisis (Figure 2).
But it’s important to remember that fixed income investors may stand to benefit from prevailing higher yields over multiyear time horizons. While the recent sharp increase in bond yields has been painful for many investors in the short term, we believe it can ultimately serve to enhance fixed income’s longer-term income generation and total-return prospects. Today’s loftier yields may also offer investors better entry points into some fixed income assets, along with a potential cushion against further interest-rate volatility in the months ahead.