In Search of Lost Yield

January 18, 2022 | Evan Frazier, CFA, CAIA, Senior Research Analyst

The fixed income space faces several significant challenges in 2022. First, the ability of many bond strategies to generate viable income streams is limited by interest rates that remain at historic lows. Additionally, elevated levels of inflation, which may remain above the Federal Reserve’s long-term target of 2.5% throughout the year, will serve to dilute real returns. To that point, the 5-year breakeven rate, a measure of expected near-term inflation in the U.S., ended last year at 2.9% after reaching a level of 3.2% just a few weeks prior, which represents a record high for the metric since Bloomberg began tracking it in 2002. As displayed in this week’s chart, Treasuries, mortgage-backed securities, and high yield municipal bonds exhibited flat-to-negative inflation-adjusted yields at the end of 2021. Finally, many expect rates to rise this year as the Fed curtails stimulus programs and begins to implement increasingly restrictive monetary policy to combat the rise in price levels. The current landscape begs the question: What can fixed income investors do going forward?

In the coming years, traditional bond investors may need to focus on a wider variety of sectors within the asset class to attain desired yields. Specifically, preferred securities, emerging market debt (EMD), high yield bonds, and senior loans all offer yields that are in excess of the 5-year breakeven rate, even when adjusting for duration. Bank loans may be particularly attractive going forward, as these instruments typically offer floating interest rates that protect investors from increases in short-term yields. Of course, the risks of each of these spaces should be thoroughly considered before any allocation changes are implemented. The EMD space, for example, carries with it significant currency risk, while preferreds exhibit credit risk and are subordinated in the capital structure, providing investors with a lower claim on assets than more senior debt. While all of these sectors are not uncommonly featured in investment portfolios, market participants should investigate the merits and drawbacks of each before creating or modifying target allocations, with a specific focus on duration, credit spread sensitivities, and liquidity terms.

Print PDF > In Search of Lost Yield

 

The opinions expressed herein are those of Marquette Associates, Inc. (“Marquette”), and are subject to change without notice. This material is not financial advice or an offer to purchase or sell any product. Marquette reserves the right to modify its current investment strategies and techniques based on changing market dynamics or client needs.

Evan Frazier, CFA, CAIA
Senior Research Analyst

Get to Know Evan

Related Content

This chart description is for illustrative purposes only and its accuracy cannot be guaranteed. Please see full disclosures at end of PDF document in the web post. General description: Combination column and line chart comparing recent holiday spending by U.S. consumers. Chart subtitle: Spending is on track to reach record levels this holiday season, despite mounting economic pressures faced by American consumers. Chart source: Adobe Analytics and CNN Business as of October 31, 2023. Chart description: Left Y-axis is labeled “Spending” and ranges from $0B to $250B. Right Y-axis is labeled “YoY Growth” and ranges from 0% to 50%. X-axis labels each column: 2019, 2020, 2021, 2022, and 2023 (Projected). Holiday Spending by U.S. Consumers is plotted in dark teal columns. Holiday Spending Growth is plotted with light purple line and markers. 2019 saw $143B in spending and 13.1% YoY growth; 2020 $188B, 32.1%; 2021 $205B, 8.7%; 2022 $212B, 3.5%, and 2023 is projected at $222B and 4.8%. End chart description. See disclosures at end of document.

11.30.2023

‘Tis the Season to Spend!

The holiday spending frenzy is well underway as some of the biggest shopping days of the year, including Black Friday…

11.16.2023

The Taming of the VIX

October proved tumultuous for investors as all major U.S. equity indices were negative and the CBOE VIX Index, which serves…

This chart description is for illustrative purposes only and its accuracy cannot be guaranteed. Please see full disclosures at end of PDF document in the web post. General description: Combination stacked column and line chart comparing unrealized gains/losses with effective federal funds rate. Chart subtitle: Unrealized losses across depository institutions have increased in recent quarters thanks to higher interest rates. Chart source: Federal Deposit Insurance Corporation and Federal Reserve Bank of St. Louis as of June 30, 2023. Chart description: Left Y-axis is labeled “Unrealized Gains/Losses” and ranges from -$800B to +$800B, corresponding to stacked columns. Right Y-axis is labeled “Rate” and ranges from -6% to +6%, corresponding to line. X-axis ranges from 1Q08 to 2Q23; labels are at 3-quarter increments to fit so last label is for 1Q23. Available-For-Sale Securities are plotted in dark green base of stacked columns; Held-To-Maturity Securities are plotted in lighter green as second half of column. Effect Federal Funds Rate line is plotted in light blue. Unrealized losses are at significant levels for chart losses; since the fed funds rate has increased since 1Q22, losses have totaled over $300B. Most recent datapoints, as of 2Q23 are as follows: Available-For-Sale Securities at -$248.9B, Held-To-Maturity Securities at -$309.6B, and Effective Federal Funds Rate at 5.3%. Please contact us for the full dataset. End chart description. See disclosures at end of document.

11.08.2023

Realizing the Impact of Unrealized Losses

Earlier this year, the regional banking crisis and eventual collapses of Silicon Valley Bank, Signature Bank, First Republic Bank, and…

This chart description is for illustrative purposes only and its accuracy cannot be guaranteed. Please see full disclosures at end of PDF document in the web post. General description: Three-line chart showing cumulative return for various U.S. equity indices. Chart subtitle: Domestic stock indices enter correction territory after recent slide. Chart source: Bloomberg as of October 31, 2023. Chart description: Y-axis is labeled “Cumulative Return” and ranges from -15% to +10%. X-axis is labeled in monthly increments, from Jun-23 to Oct-23. Data ranges 6/30/23 through 10/31/23. S&P 500 Index is plotted in orange line, Nasdaq-100 Index in light tan line, and Russell 2000 Index in dark purple line. Most recent data points, respectively, -5.31%, -4.84%, -11.61%. Please contact us for the full dataset. End chart description. See disclosures at end of document.

11.01.2023

The Chart for Red October

U.S. equities declined for the third consecutive month in October amid an environment of higher yields and underwhelming earnings reports…

10.13.2023

3Q 2023 Market Insights Video

This video is a recording of a live webinar held on October 26 by Marquette’s research team, featuring in-depth analysis…

10.26.2023

Portfolio Trick or Treat

Coming into 2023, investors were cautiously optimistic about 2023 market returns; cautious considering the broad losses across asset classes during…

More articles

Subscribe to Research Email Alerts

Research Email Alert Subscription

Research alerts keep you updated on our latest research publications. Simply enter your contact information, choose the research alerts you would like to receive and click Subscribe. Alerts will be sent as research is published.

We respect your privacy. We will never share or sell your information.

Thank You

We appreciate your interest in Marquette Associates.

If you have questions or need further information, please contact us directly and we will respond to your inquiry within 24 hours.

Contact Us >