This article was taken from the Spring 2024 issue of The 1875. To subscribe to our investment publications, please visit www.redmayne.co.uk/publications
Fixed-income investments have seen a resurgence in investor attention amid higher interest rates and have been a frequent topic of discussion in Redmayne Bentley publications. Having provided poor returns a few years prior, investors are once again enthusiastic about bond markets and the yields on offer. Once limited solely to the secondary market, developments in early 2024, with the launching of a new retail access platform by
Winterflood Securities is enabling participation by retail investors in gilt auctions, potentially sparking further interest in gilts by individual investors.
When thinking of fixed-income, corporate and government bonds are the first to come to mind, but these are just the tip of the iceberg for a market estimated to be worth US$133tn in 2022. UK investors tend to focus on the domestic Sterling market, limiting themselves to just 3% of the global market. A lack of familiarity, or desire for simplicity, are likely contributing factors, but for those willing to look further afield, their attentions could be turned to multi-sector strategies, similar to the strategic bond funds that are likely to hold a place in client accounts.
Within strategic bond funds and other flexible fixed-income funds, the managers have two strings capable of being pulled in generating returns, interest rate and credit risk exposures. Put simply, they can buy longer or shorter dated bonds to adjust interest rate exposures and higher or lower quality bonds in risk-on or risk-off periods. Mostly limited to government and corporate bonds, these strategies still leave significant parts of the fixed-income market untouched.
Untouched areas of the market include assets such as securitised bonds, which in the simplest terms are numerous assets pooled into a new legal entity to support a bond issue. One of the most common types of securitised bonds remains mortgage-backed securities (MBS), famously at the centre of the 2008 global financial crisis. Mentioning these investment vehicles can cause alarm bells to ring for some, with torrid memories of the events some sixteen years ago. However, the MBS market has changed significantly, with improving lending standards and a shift to their issuing by government-sponsored enterprises such as Freddie Mac and Fannie Mae. Today, the MBS market in the US remains one of the most traded markets globally, with an estimated market size of US$9.3tn. The structure is easily adaptable to a variety of assets from commercial mortgages, student loans, credit cards and private company loans.
The expected question at this point is why? Why might someone want access to such assets in their portfolios? Diversification is the initial response. With many portfolios’ fixed-income allocations focused on government or corporate bonds, these assets can provide a diversified return stream that potentially lowers risk in a portfolio. Over time, aggregate fixed-income indices have become significantly more interest rate sensitive, as longer-dated bonds were issued to take advantage of lower debt costs. Adding assets with lower interest rate sensitivity can balance holdings in other strategies where more interest rate risk is being taken. A second reason could be valuations-based, with securitised sectors trading well relative to history and compared to standard corporate benchmarks where valuations could be argued to be stretched.
This is all well and good, but accessing such asset classes can be tricky for a private individual. Specialist funds in the area are usually limited to institutional investors with significant assets, buying direct is out of the question, and some significant expertise is required in the area. Luckily, some of the larger asset managers such as PIMCO, the US asset manager with some US$1.8tn of assets under management, hold the solution. Its US$220bn income strategy is well known within the industry, designed to provide smooth through-cycle returns via investment across the fixed-income spectrum and offers an attractive monthly income in the process. The diverse portfolio holds nearly 40% in mortgage-backed securities, 20% in US treasuries and smaller allocations to areas such as commercial mortgages and emerging market bonds.
With gilts still a go-to asset for many, as shown by the UK platforms earlier in this article, investors run the risk of over-concentration in a small area of the global market, potentially missing attractive opportunities elsewhere. A multi-sector bond strategy could be the answer for those looking to diversify and balance portfolio risks.
Please note that this communication is for information only and does not constitute a recommendation to buy or sell the shares of the investments mentioned. Investments and income arising from them can fall as well as rise in value. Past performance and forecasts are not reliable indicators of future results and performance.