Clients often talk about choosing the right fixed-income tool for the job in retirement investing.
Investing in retirement often requires a different approach than it did when clients were earning – most significantly, clients are more likely to be focused on income creation than on generating wealth for the future.
By using the right tools for the job, fixed income can help clients achieve this in retirement planning.
In our view, a strategic bond approach can give retirement clients access to their goals of income generation, capital preservation and growth all in one place.
It offers a solution for investors seeking the safety of fixed income, while aiming for higher returns than a typical static fixed-income allocation such as cash, government bonds and credit.
Typically, when thinking of the asset types used in a strategic bond strategy, one might think about allocation across government and corporate bonds, with a limited use of derivatives, predominantly for hedging risk.
A typical strategic bond approach applies no benchmark constraints and will not have rigid allocations, allowing for greater flexibility in accessing asset classes.
If we think about the sources of potential returns targeted by such approaches, they will generally look to generate returns from up or down movements in yields and credit spreads, alongside allocations seeking to generate returns from relative-value positioning between sectors and asset classes.
Whether it’s government or corporate bonds, financial or non-financial debt, when picking the right bonds, the real assessment is whether one issuer will outperform another.
Fixed income is often viewed as a lower-risk asset class
In our view, there is a strong advantage to a strategic bond approach over alternatives – such as advisers choosing individual bonds themselves with different pockets of assets.
With a strategic approach, a client’s investments are all in one place, allowing for efficient transformation of the allocation and the risk profiles in a holistic and more timely fashion.
Fixed income is often viewed as a lower-risk asset class. Of course, there are clients – including those at planning for retirement – who will focus on more growth-orientated strategies and therefore have riskier bonds, and others who want more capital protection, and are therefore looking at lower-risk strategies.
However, the turmoil in the UK government bond market in September 2022 showed that fixed income can be a challenging asset class. Many retired clients will have had assets in fixed income, and some of them will have seen negative returns as a result of the unexpected volatility.
It has become evident that there were managers either with very long duration bonds, meaning they were more sensitive to interest rates, or managers with riskier bond allocations in the high-yield space.
Earlier in 2022, credit spreads widened and bond yields rose very aggressively as a result of the significant supply-chain disruption and inflationary impulses emanating from the Russia/Ukraine conflict.
In response, central banks aggressively hiked rates and risk markets suffered, which led to negative returns across fixed-income markets.
Strategic bond strategies can offer the potential for strong capital protection
There are lessons to be learned here. For advisers with a client invested in a growth-oriented strategy, considerations need to be made to assess the risks that are actually being run and any underlying risk.
A number of managers with long-duration bonds, which fell very sharply during the late 2022 volatility, were not quick to change asset allocations and shift durations shorter. This suggested that perhaps the potential and underlying risks were not fully assessed in advance.
Against unexpected market swings or a weak fixed-income market backdrop, strategic bond strategies can offer the potential for strong capital protection and the ability to shift asset allocations efficiently.
By taking a global approach to strategic bond investment, there is no necessary home bias, which allows for two options: to seek the best opportunities around the world, but also the ability to pick up opportunities domestically when they appear.
In order to balance return efficiency with diversification, it is vital to avoid concentrating bets in any one area and to dynamically allocate across asset classes, rather than having a static asset allocation.
Bond yields have come off the historical lows seen after the financial crisis and peaked in the last few years, and we expect those high yields to be here in the medium term – based on our expectations of volatile geopolitics, inflationary tailwinds that keep inflation higher, and government borrowing remaining elevated.
As a strategic bond investor, I am not forecasting over the next few years any material recession in developed markets, and we expect a ‘soft landing’ for economic growth. From this perspective, the number of interest-rate cuts priced into most developed markets is too many and too fast.
In that environment, the attractive income and potential return generation offered by fixed-income markets should be competitive, and probably better than equities on a risk-adjusted basis, in our view.
Damien Hill is senior portfolio manager at Insight Investment on the Responsible Horizons fund range
