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Ask the investment professionals: What should I do for fixed income?

Submitted by Brian.Lavelle on September 9, 2019

Two Schwab investment professionals discuss the yield curve, and how much risk to take in order to reach a yield target. Should investors pursue active or passive strategies in fixed income? Hear what they have to say in this short video.


[GRAPHIC: Ask the investment professionals]

[GRAPHIC: Where is the right spot to be on the yield curve for fixed-income investors?]

KATHY: Well, I don't think there's any one right spot, and, actually, there rarely is. If you look at kind of the history of performance, it's pretty rare that a bullet strategy, where you pick one spot on the yield curve, will outperform either a ladder or a barbell.

We have been suggesting barbells in this environment because the yield curve has such a weird shape right now. I've been calling it the big dipper, where, you know, it kind of dips from about one year out to seven or so. And so our thought is to have some short-term and some intermediate-term. [26:25 ]

GRAPHIC: [Does it make sense to chase yield in this environment?]

BRETT: Well, I'm glad you didn't ask me, how do you maximize your yield, because that, to me, is one of the most dreaded questions I could possibly receive, for two reasons.  Number one is I don't have a good answer, and, number two, I think it's the wrong question to ask, because it implies that higher-yielding strategies are better than lower-yielding strategies.  There's an expression that was coined by a Wall Street commentator a long time ago that went something like this: ‘More money has been lost reaching for yield than at the point of a gun.'

Most typically, when investors reach for yield, they're doing so in the credit kind of markets.  Point in fact, if this was 10 years ago, and you said, ‘Hey, I got to have a 5% yield,' you could do so with Treasuries, okay?  If you went back five years ago, perhaps you could get a 5% yield with investment-grade corporate bonds, not quite as safe, but they're doing okay. Today, if you want a 5% yield, you would probably have to go into the high-yield market.  So does it make sense to keep taking on increasing risk, which is correlated with the equity markets, in order to reach a yield target?  I think that's probably one of the biggest mistakes an investor could make.

GRAPHIC: [Should investors pursue active or passive strategies in fixed income?]

BRETT: I would distill it down in the following way:  From one lens, it's a philosophical question about how you view markets, inefficiencies versus efficiencies, what managers have truly the ability to add value over time, and are you willing to pay for that. So those are kind of the broad-based topics that equity has in common with fixed income. 

Now, the difference between the way in which active strategies work in equities versus fixed income tends to be the following:  In the equity space, we know that there are all sorts of strategies that managers can use to add value—rotating between sectors, large-cap and small-cap, value versus growth, bottom up, top down, quantitative strategies, etc.  In the active space in the bond world, there tends to be what looks like lots of different strategies, but I can tell you 9 out of 10 of the active strategies in the fixed income space tend to be focused on overweighting yield.

And so it begs the question is that really a value-added strategy?  Are they really adding alpha or are they… is it more of a beta play by simply doing a higher-yielding kind of strategy? One of the first questions that I always ask an active manager is, ‘What's the yield on your portfolio relative to the benchmark?' And if it's higher, I ask why, and then how often, and ‘Would you ever have a strategy that was underweight from a yield perspective, or [is] this just a structural bias?'  Because if it is, it calls into question whether you really want to pay for that active strategy. Not to mention the fact that if you're using fixed income in your portfolio to offset risks in equities, we all know that higher-yielding strategies tend to behave in a way that's correlated with equities, particularly in a stressed market, and that may not be what you want to do.

GRAPHIC: [Charles Schwab own your tomorrow]

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