Fixed Income has always played the role of protector within a portfolio. While equities are forgiven when they behave erratically, and even expected to, fixed income is generally responsible for reducing risk and serving up healthy income to its investors.
Recently, however, traditional fixed income assets have struggled to find this healthy yield to serve. The 10-year government bond, the epitome of all that is safe, is serving up 0.6%.¹ Corporate bonds and high yield aren’t stepping up either. Corporate bonds are yielding around 2.0%² and high yield recently dipped to a new low record of 4.6%.³ With interest rates expected to remain this low for the foreseeable future, widening one’s cognitive aperture to continually find good investments is going to become critical to producing quality results.
High yield is roughly 15% of overall corporate (investment grade) U.S. bond market, which itself is estimated at roughly $8.1 trillion.⁴ And while that means the bond pond is far from over-fished, the trick is to look beneath and between the common.
Other income generating securities like certain defensive equities, preferred shares, or equity-linked instruments for debt investors, may be the way to go. Convertible bonds, while not completely uncommon, have been largely overlooked. The upside potential of these bonds outweighs that of traditional fixed income because of their ability to capture any gains in the issuer’s equity share price, while at the same time providing protection against a potential decline. Talk about serving and protecting.
Over the last 2 years, U.S. Convertible bonds have outperformed equities and traditional fixed income.⁵ More recently, as indicated by the above graph, their performance during the pandemic has been a compelling case for including this asset in your fixed income portfolio.
¹ Source: Bloomberg. 10-year Canadian government bond yield as of October 31, 2020.² ICE BofA U.S. Corporate Index Effective Yield. Source: FRED Economic Research. As of November 9, 2020. ³ ICE BofA U.S. High Yield Index Effective Yield. Source: FRED Economic Research. As of November 9, 2020. ⁴ S&P Global High Yield Bond Primer, https://www.spglobal.com/marketintelligence/en/pages/toc-primer/hyd-primer#sec1 ⁵ ICE BofA U.S. Convertible Excluding Mandatory Index. Source: Capital IQ and Federal Reserve Bank of St. Louis.