Views expressed are those of the authors and are subject to change. Other teams may hold different views and make different investment decisions. The value of your investment may become worth more or less than at the time of original investment. For professional or institutional investors only. Your capital may be at risk. Please refer to any investment risks noted near the end of the PDF available below.

KEY POINTS

In today’s challenging fixed income environment, we think investors seeking total return from fixed income are best served by a three-pronged framework supported by robust risk management:

  • Strategic themes that may benefit from structural repricing
  • Market-neutral absolute return strategies to potentially buffer against down markets
  • Tactical opportunities that attempt to capture specific short- to medium-term mispricings
FOR NEARLY 40 YEARS, FIXED INCOME INVESTORS HAVE BENEFITED FROM DECLINING YIELDS AND LOW VOLATILITY. This secular trend helped make bonds not only a reliable source of income, but also a substantial generator of total return, reducing the need for diversification in fixed income portfolios. Indeed, since 2006 over 90% of the total return of the Bloomberg Barclays US Aggregate Index can be attributed to US Treasury movement (Figure 1).

However, many fixed income credit and emerging markets sectors produced double-digit negative total returns during the first quarter of 2020. In addition, the yield on the Bloomberg Barclays US Aggregate was 1.3% as of the end of April and several government-bond markets traded at negative yields. With that in mind, many investors are wondering whether fixed income still has the potential to generate the total returns they seek without excess volatility.

FIGURE 1

Time for a broader tool kit?

We propose one possible blueprint that we believe gives investors the opportunity to maximize total returns in a world of low yields. This approach rests on three main drivers of total return within fixed income: longer-term strategic sector/thematic positions, market-neutral investing, and tactical positions/hedging. The interplay of these three components can offer a flexible structure for capturing complementary total-return opportunities while still providing the “anchor to windward” desired from bonds (Figure 2).

FIGURE 2

Three drivers of total return

Strategic themes/sectors

This component comprises three to five long-term ideas for capturing the anticipated repricing of structural themes occurring over several years. Typically, three criteria identify such opportunities.

The first is that the sector is currently out of market favor, perhaps due to long periods of underperformance, and therefore likely to be trading at very attractive valuations. Second, the sector is regarded as…

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