Schwab IMPACT speakers: Fixed income having strong year, will remain key in diversification

Fixed income has seen strong demand amid a global economic slowdown, a shift in demographics and relatively low US inflation, and investors should maintain bonds as a crucial part of their portfolios in the years ahead, said experts at Schwab IMPACT in San Diego this week.

A population that is aging — and shrinking in some countries — is a major factor behind the “insatiable demand” for fixed income, said Gautam Khanna, a senior portfolio manager at BNY Mellon subsidiary Insight Investment. That aging population is weighing on growth and inflation, said Kathy Jones, senior vice president and chief fixed income strategist at the Schwab Center for Financial Research.

Addressing growing investor worries, the experts voiced no major concerns that a recession is looming in the next 12 months. Liz Young, director of market strategy at BNY Mellon Investment Management, said fear is coming into play and downside risks have increased, but that “does not mean Armageddon is around the corner,” because “recessions are rarely caused by things we saw coming.”

However, she also said that the positivity in the markets “has been predicated on a strong consumer, which is dependent on a strong labor market.”

“If either of those two things start to falter, then we have a problem. ... The big risk right now is that the market is afloat because of expectations, not events,” she said.

Bonds are important to offset any drops in the stock market, and taking risks in equities and in bond duration is an important part of diversifying, Young said.

“Corrections and bear markets without a recession are buying opportunities,” with the fourth quarter of 2018 being a recent example, she said.

Looking forward, Jones outlined a fixed income strategy that involves:

  • Extending duration opportunistically when “bumps” in yield are available
  • Seeking higher credit quality, including being “very cautious” about BBB-rated bonds
  • Considering Treasury Inflation-Protected Securities, or TIPS

She recommends looking into TIPS as a “small slice” of portfolios because the Federal Reserve has been focused on raising inflation expectations, and TIPS can be a hedge against the Fed having success in heightening those expectations, she said.

Khanna said an active strategy “is the way to go” in fixed income. There is “limited slack” in the economy, which means “policy is beta,” with a great deal of attention focused on factors including officials’ tweets and the Fed chairman’s statements, Khanna and Young said. Portfolios need duration as “ballast” to smooth out their total return profile in case volatility or an unforeseen risk emerges, Khanna said.