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Staying the Course: Key Takeaways From Our 2021 Advisor Fixed Income Portfolio Review

We examine key themes from our review of advisor fixed income portfolios over the past year.

The first quarter of 2022 was the most volatile period for fixed income in decades, marked by sharp increases in interest rates and negative returns across fixed income allocations. It followed similar bouts of turbulence in 2021 and 2020.

While volatility can make it challenging for investors to remain disciplined, those with a long-term approach can potentially find compelling return opportunities. The reason? As yields rise, bond portfolios may suffer short-term losses, but future return potential adjusts higher. The challenge lies in building well-diversified portfolios and calibrating expectations to navigate volatility and realize those future returns.

In our 7th annual review of advisor fixed income portfolios we identify key themes from the 1,400 portfolios we analyzed in 2021 and share how PIMCO is positioning fixed income allocations amid high inflation and rising rates. Key themes include:

  • Clients continue to favor high quality duration complemented by more flexible and credit-oriented multi-sector strategies.
  • Higher starting yields and wider spreads bode well for future returns in both duration and credit-sensitive sectors.
  • With thoughtful portfolio construction, bonds can continue to provide key benefits, including income generation, equity diversification and capital preservation.

Putting 2022 into context

The bond market’s sell-off in the first quarter of 2022 was historic, with sharp increases in inflation and interest rates driving negative returns in both duration and credit-centric fixed income sectors. Yet the sell-off has resulted in much more attractive yields, boding well for future returns (see Figure 1).

  In Figure 1, the left-hand chart is a line graph showing the Bloomberg U.S. Aggregate Bond Index’s five-year return starting from January 1976. The five-year forward return peaked at just above 20% in August 1981 and fell steadily to a low of 1.2% on 30 April 2017 with a 94% correlation to the index’s starting yield over that span. The chart shows the current yield rising from a low of 1.36% in July 2021 to 2.92% as of 31 March 2022. The table at the right shows the trailing three-year and forward five-year returns of the Bloomberg U.S. Corporate High Yield Excess Return Index based on the percentile rank of average spread levels. For example, in the 80th to 100th percentile category, the average spread was 869 basis points. The corresponding three-year trailing return was -5.03% and the three-year forward return was 8.30%. By contrast, in the zero to 20th percentile category, the average spread level was 291 basis points. The corresponding three-year trailing return was 5.29% and the three-year forward return was -2.94%.  The time period used for the high yield returns is from December 1992 to 31 March 2022.

Furthermore, strong future returns in fixed income have often historically followed poor trailing returns. Looking forward, higher starting yields present a potentially attractive entry point even though recent performance can make this seem intimidating.

The 2021 average advisor portfolio

In 2021, clients continued to favor a balance of high quality duration via core-plus allocations complemented by more flexible and credit-oriented multi-sector strategies (see Figure 2). This approach can help balance the diversifying benefits of duration with a more attractive yield through diversified credit allocations. Market volatility has some questioning the value of fixed income within a broader portfolio but, with thoughtful portfolio construction, bonds can continue to provide key benefits, including income generation, equity diversification and capital preservation.

Figure 2 is a pie chart showing the average advisor’s fixed income portfolio allocation in 2021. It shows that allocations remain focused on core and multi-sector strategies. For example, intermediate core-plus bonds made up 24% of the total allocation, followed by multisector bonds at 21.5%, short-term bonds at 11.1%, and nontraditional bonds at 7.4%. Inflation-protected bonds and intermediate government bonds had the lowest allocations at 2.7% each. The data is based on PIMCO and Morningstar as of 31 December 2021 and takes into account 1,431 advisor portfolio reviews broken out by Morningstar fixed income category.

The road ahead

Managing the challenges within fixed income requires focusing on several key areas.

  1. Clearly define fixed income portfolio objectives according to specific risk and return characteristics. In this environment, different objectives often involve trade-offs. For example, increasing the yield (and therefore return potential of the portfolio) may result in less equity diversification in risk-off environments.
  2. Remain diversified, especially across interest rate and credit risks, to help reduce downside risks and provide more consistent outcomes across market environments. For example, core bonds and high yield bonds each have very different drivers of risk and return.
  3. Discipline remains important. Rising yields lead to higher long-term returns for fixed income investors, but that requires staying invested during more challenging periods.

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

  • PIMCO Pro, our digital service platform, uses PIMCO’s proprietary analytics to create a custom investment dashboard to view interactive data, stress test portfolios, and drill into portfolio volatility by risk factor. PIMCO Pro also has tools to assess return potential and evaluate retirement strategies.
  • Our team of PIMCO Pro specialists can create customized, deep-dive portfolio reviews that help you understand performance drivers.
  • 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: “Staying the Course: Evaluating Advisor Fixed Income Portfolios Amid High Inflation and Rising Rates.”

Justin Blesy is an asset allocation strategist, and Brian Kyle is a member of the global wealth management team.

The Author

Justin Blesy

Asset Allocation Strategist

Brian Kyle

Global Wealth Management

Related

Viewpoints
Evaluating Advisor Fixed Income Portfolios Amid High Inflation and Rising Rates

A disciplined approach to fixed income investing in the current environment can lead to compelling long-term returns.

Disclosures

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

All investments contain risk and may lose value. 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. 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. 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.

Statements concerning financial market trends or portfolio strategies are based on current market conditions, which will fluctuate. Different types of investments involve varying degrees of risk. There is no guarantee that these investment strategies will work under all market conditions or are appropriate for all investors and each investor should evaluate their ability to invest long-term, especially during periods of downturn in the market. No representation is being made that any account, product, or strategy will or is likely to achieve profits, losses, or results similar to those shown.

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Balancing Act: Evaluating Advisor Fixed Income Portfolios for the Road Ahead
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