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Preparing for the Pivot: Key Takeaways From Our 2022 Advisor Fixed Income Portfolio Review

Higher bond yields and improved total return potential may offer advisors a compelling opportunity to move cash off the sidelines.

Many advisors who moved into cash last year as interest rates rose sharply are asking: When is it time to get back in to longer-term fixed income investments and how?

The outlook for fixed income appears compelling after last year’s sell-off, which was spurred by Fed interest rate hikes. Starting yields across most fixed income sectors are the highest in more than a decade. Since yield has tended to be a powerful indicator of forward returns, the five-year return expectation for the average advisor portfolio doubled to 4.7% in December 2022 from 2% in December 2021. Higher yields also potentially provide a stronger cushion against further rate hikes or spread widening, offering more attractive downside protection than a year ago.

Bonds are back

The question on most advisors’ minds focuses then on timing. Is it best to wait for the Fed to pause rate hikes before stepping out of cash? In our 8th annual review of advisor fixed income portfolios, we analyzed this question among others and concluded that now may be a good time to move cash off the sidelines into fixed income despite recent volatility.

Figure 1 shows core fixed income performance relative to cash over the last seven Fed rate-hiking cycles since 1980. Over the typical 19-month cycle, rates initially rise and core fixed income underperforms cash, as happened in 2022 when the Fed began aggressively raising rates.

However, before the Fed reaches its peak policy rate (i.e., before it pauses or cuts), intermediate yields begin to fall on average and core fixed income allocations start to meaningfully outperform cash. While cash can mitigate downside risk as markets anticipate future rate hikes, the time to step out of cash typically comes as the Fed approaches its peak policy rate. At the time of this publication, we believe the Fed may soon pause its hikes as it evaluates the path of inflation.

Figure 1: This chart shows the relative performance of the Morningstar Core-Plus Bond Category and 3-month Treasury bills on average over the last seven fed hiking cycles dating back to the early 1980s. It illustrates that average 1-year forward returns for core bonds started to outpace cash about four months before the Fed reached its peak policy rate.

In evaluating the trade-off between T-bills and other options within fixed income, it’s important to note that core bonds and the Morningstar short-term category have consistently outperformed cash over periods of three years or more, the minimum horizon of most clients’ long-term investments. Figure 2 shows that core bonds have beaten cash 91% of the time over rolling three-year periods since 1978, with an average outperformance of 2.9 percentage points. Similarly, strategies in the Morningstar short-term category have also demonstrated outperformance over most periods. Therefore, for most investors with reasonably long investment horizons, elevated cash allocations should be considered a short-term decision given the expected long-term advantages of remaining invested in high quality fixed income, in our view.

Figure 2: This chart shows the rolling three-year returns of the Bloomberg US Aggregate Index, 3- month Treasury bills and the Morningstar Short-Term Category. In 91% of the 3-year periods, the US Aggregate outperformed T-bills by 2.9% on average annually. In 78% of the 3-year periods, the Morningstar Short-Term Category outperformed T-bills 78% of the time by an annual 1.2% on average.

Looking ahead

With today’s inverted yield curve, many advisors have increased allocations to cash and short-term strategies within their fixed income portfolios. While this was an effective strategy in 2022, it’s important to consider the improved risk and return profile of fixed income strategies given today’s higher yields and the potential for an economic slowdown.

PIMCO offers tools to help advisors navigate the investment and behavioral challenges of fixed income investing in the current environment:

  • PIMCO Pro’s proprietary analytics allow advisors to drill into portfolio volatility by risk factor, stress test portfolios, and keep apprised of rapidly moving markets. PIMCO Pro also has tools to assess return potential and evaluate retirement strategies.
  • Our solutions team and PIMCO Pro specialists can create customized, deep-dive portfolio reviews that help advisors understand performance drivers across fixed income, equities and alternatives.
  • PIMCO model portfolios are available for direct investment on select investment platforms or to provide guidance on how to address specific investor objectives.

For financial advisors registered on the site, a more detailed discussion can be found here: “Preparing for the Pivot: Evaluating Advisor Fixed Income Portfolios After 2022's Historic Rise in Rates.”

The Author

Justin Blesy

Asset Allocation Strategist

Brian Kyle

Global Wealth Management

Wade Sias

Strategist

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Disclosures

Past performance is not a guarantee or a reliable indicator of future results. 

All investments contain risk and may lose value. Asset allocation is the process of distributing investments among various classes of investments (e.g., stocks and bonds). It does not guarantee future results, ensure a profit or protect against loss. Investing in the bond market is subject to risks, including market, interest rate, issuer, credit, inflation risk, and liquidity risk. The value of most bonds and bond strategies are impacted by changes in interest rates. Bonds and bond strategies with longer durations tend to be more sensitive and volatile than those with shorter durations; bond prices generally fall as interest rates rise, and low interest rate environments increase this risk. Reductions in bond counterparty capacity may contribute to decreased market liquidity and increased price volatility. Bond investments may be worth more or less than the original cost when redeemed. Corporate debt securities are subject to the risk of the issuer’s inability to meet principal and interest payments on the obligation and may also be subject to price volatility due to factors such as interest rate sensitivity, market perception of the creditworthiness of the issuer and general market liquidity. Investing in foreign-denominated and/or -domiciled securities may involve heightened risk due to currency fluctuations, and economic and political risks, which may be enhanced in emerging markets. High yield, lower-rated securities involve greater risk than higher-rated securities; portfolios that invest in them may be subject to greater levels of credit and liquidity risk than portfolios that do not. Bank loans are often less liquid than other types of debt instruments and general market and financial conditions may affect the prepayment of bank loans, as such the prepayments cannot be predicted with accuracy. There is no assurance that the liquidation of any collateral from a secured bank loan would satisfy the borrower’s obligation, or that such collateral could be liquidated. Income from municipal bonds is exempt from federal income tax and may be subject to state and local taxes and at times the alternative minimum tax. Sovereign securities are generally backed by the issuing government. Obligations of U.S. government agencies and authorities are supported by varying degrees, but are generally not backed by the full faith of the U.S. government. Portfolios that invest in such securities are not guaranteed and will fluctuate in value.

Figures are provided for illustrative purposes and are not indicative of the past or future performance of any PIMCO product.

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Forecasts, estimates, and certain information contained herein are based upon proprietary research and should not be considered as investment advice or a recommendation of any particular security, strategy or investment product.

The PIMCO Models described in this material are available exclusively through investment professionals. PIMCO Models are based on what Pacific Investment Management Company LLC (together with its affiliates, “PIMCO” ) believes to be generally accepted investment theory. PIMCO models are for illustrative purposes only and may not be appropriate for all investors. PIMCO Models are not based on any particularized financial situation, or need, and are not intended to be, and should not be construed as, a forecast, research, investment advice or a recommendation for any specific PIMCO or other strategy, product or service. Individuals should consult with their own financial advisors to determine the most appropriate allocations for their financial situation, including their investment objectives, time frame, risk tolerance, savings and other investments. Volatility is historical and is likely to change over time. PIMCO has not undertaken, and will not undertake, any analysis to determine any specific models’ suitability for specific investors. Strategy availability may be limited to certain investment vehicles; not all investment vehicles may be available to all investors or in all geographical regions. Please contact your PIMCO representative for more information.

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Preparing for the Pivot: Advisor Fixed Income Portfolios After 2022’s Historic Rise in Rates
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