'Regime change for investors': yields make fixed income attractive again

DANIEL JOHNSON

AFTER a long period of poor returns, investors are once again seeing value in the fixed income market.

Bond yields have been on the rise over recent months because of worries including high inflation and government debt levels. The 10-year U.S. Treasury was trading above five per cent this month, while Canada's bond was nearly four per cent.

Higher bond yields and rising interest rates mean that retail investors with equity-heavy portfolios might want to reconsider their exposure to fixed income.

“We are back to something that's normal,” said Alex Lee, chief investment officer at Atrium Wealth Management, based in Vancouver, Canada and the U.S.

“It is line with fundamentals, but the issue is we haven't seen this level of yield in 25 years. So it's a regime change for investors.”

In conversations with his client base — mostly financial advisers, he said he sees some long-held assumptions being challenged. For example, it has been burned by fixed income for so long. “During 2010s, MacMullen said there was little appetite because of mutual returns. Income products were not exciting.”

MacMullen said the change in the bond market means that fixed income can once again play a more attractive role after falling out of favour when yields were lower.

“Governments and large companies need to borrow money, and there will always be some promise of repay that money along with a certain amount of interest.”

Fixed-income investments often falls within investors due to factors like inflationary pressure, buyers can get them cheaper, but that bond will pay the same interest rate. This means they could potentially get a larger return via higher yield.

Alex Lee, senior fixed income client portfolio manager at Vanguard Canada, said he thinks the regime change for investors' yields make fixed income attractive again is real.

“I think it's a good thing for investors,” Lee said. “I think it's a good thing for the markets. I think it's a good thing for the economy.”

Lee said the number of rate hikes priced in the market to come suggests the Bank of Canada is done and ready to raise rates once by the end of this year and again by the end of next year. For the U.S. Federal Reserve, he said Vanguard expects one additional rate hike this year.

“We're going back to that zero-rate environment. We think interest rates have normalized to a point where ... now fixed income actually provides value for a portfolio,” Lee said.

“That contrasts with a low-yield environment, where the returns may not outpace inflation. If you look at the last five years, we're getting close to surpassing last year's flow. We've seen pick up in flows into bonds and bond funds.”

Haliza Datuk, vice-president and portfolio manager of global bonds at Mackenzie Investments, said that changes in the bond market have created income opportunities “certainly attractive.”

“If you were to buy a simple credit ETF in the past, you would be looking at maybe a two-per-cent collect more than the dividend yield you would get on the stocks,” she said. “And the level of valuation is very different. People are actually being paid for what they think are expensive. They're actually close to what we would call overvalued, and that creates a better outlook for them to perform in the future from here,” she said.

She said inflationary pressures from the Middle East risk environment have also been driving up bond yields, which she thinks could provide products can offer protection against rising inflation.

She also said she sees value in corporate bonds. “If you look at corporate bonds, corporations, we have high-quality banks, utilities, regulated businesses that you can purchase via credit ETFs that offer a much higher yield compared to all these risks that capture the higher yields coming from owning a corporate bond versus a government bond,” Datuk said.