Fixed-income investing as interest rates drop

As central banks continue to cut interest rates, fixed-income investors should be proactive about their holdings. 

“The easy money to be made in terms of purely riding the wave of interest rates coming down and fixed income outperforming — that’s probably behind us,” said Aaron Young, vice-president of global fixed income with CIBC Asset Management, in a recent interview.

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“There’s still more opportunity here,” Young said, but that opportunity will be “a little more nuanced.”

He suggested investors focus on total return, which is a combination of “price appreciation through further cuts in rates, picking the right bonds, and also the income potential that comes with yields where they are right now, and the ability to build a relatively safe portfolio that will generate an income that’s still interesting for your clients.” 

In particular, investors should focus on the “flexibility premium,” Young said.

“The focus becomes total return and can you be flexible with capital to find the best opportunities in the space,” he said.

Fixed-income managers who demonstrate that flexibility will have the advantage going into 2025, he said.

Fixed-income investors should consider opportunities beyond broad benchmarks, Young suggested. And volatility — whether from divergent monetary policy among central banks, geopolitics or the U.S. election — also presents opportunities in the fixed-income market.

“If you can find a manager that has that flexibility to be able to take advantage of that [volatility], we think that’s how fixed income continues to be a really strong portion of your total portfolio going forward,” Young said.

He also noted that longer-term yields are rising. “Now, you actually get paid a bit to go out the curve or put money into solutions that have a duration, or average term to maturity, that’s longer than, say, one or two years,” he said. 

That means investors should overcome any recency bias they may have about avoiding interest rate risk.

“Right now, in the time where the curve is steepening, it really pays to go … intermediate duration, moving out to say a four- or five- [or] six-year kind of profile,” he said. “Yields are still attractive — lock those in now.”

Investors should also be aware of where their yield is coming from, Young said, noting that bond yield comprises the base rate and the spread, or the additional compensation an investor is paid to take on credit risk.

With base rates at attractive levels, investors can earn solid yields without taking on a lot of credit risk. 

“You don’t need to put your neck out egregiously to earn an attractive yield,” Young said. 

For those investors focused on yield, Young recommended they ensure they’re adequately compensated for taking on any additional credit risk.

“We’re not saying avoid corporate credit risk or avoid private credit. There’s lots of really interesting opportunities there,” Young said.

“But if you’re buying it purely for yield, you want to make sure the manager you choose … is very risk aware, knows where the best compensation for that credit risk is and is not just putting forward an all-in yield number that on the surface looks attractive.”

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