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The Discreet Charm of Fixed Income

Executive Summary

  • It sometimes pays to state the obvious: Some might say that fixed income is in a pickle. After all, real bond yields have trended down for the past 60 years. 10-year real yields are now negative in many major markets.
  • Yet what seems obvious isn’t necessarily true. Viewed discretely or in the context of a diversified portfolio, bonds continue to offer numerous benefits and potential for appreciation:
    • Interest rate fundamentals remain broadly supportive, and rates have the potential to fall further.
    • Fixed income, particularly credit, remains attractively priced relative to equity, which is valued near historical highs. Furthermore, private credit continues to outperform public high yield, a trend likely to be supported by continued bank regulation.
    • The probability of stocks outperforming Treasuries over the next 10 years may only be 65%, based on our simple model and historical data. If we assume mean reversion in the CAPE ratio, this probability could be substantially lower.
    • Bonds may continue to serve as a potent hedge in broad portfolios. Investors targeting a low portfolio equity beta may well consider increasing their fixed income allocation.
    • The bond market has historically provided much better sources of alpha than the equity market in general, for reasons explained in Baz et al. (2017).

For an abridged version of this article, read our blog post, “Fixed Income: Low Yields Don’t Tell the Whole Story.”

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