Perhaps the most important lesson of the COVID-19 pandemic for fixed income investors is just how critical it is to be flexible. Specifically, to have the flexibility to invest in fixed income sectors outside of broad fixed income indexes.
Two portfolio managers who have long embraced this notion of âinvesting beyond the indexâ are Weitz Investment Managementâs fixed income portfolio managers Tom Carney, CFA, and Nolan Anderson. Tom has been managing fixed income funds at Weitz for 25 years and was joined by Nolan in 2014.
THE FEDERAL RESERVE HAS INDICATED IT WILL LOOK PAST INFLATION AND KEEP INTEREST RATES LOW. BUT AS THE ECONOMY CONTINUES TO SHOW SIGNS OF STRENGTH, DO YOU SEE THE FED STICKING TO ITS STATED PLAN?
TOM: The short answer is yes. Weâve been downthis path of âzero interest rate policy,â or ZIRP, before. From December 2008 to December 2015, the Fed kept short-term interest rates at zero. Today, weâre seeing a sequel of sorts, and it seems this could just be the start of another long run. We think this is especially likely given the Fedâs new average inflation targeting directive to allow inflation to run moderately above 2% for some time.
NOLAN: I think itâs clear that weâve seen fiscal andmonetary policy shift in a way that could drive inflation
above that target. One quote that I think tells the story is from San Francisco Fed president Mary Daly, who said in February 2020 about the coming Fed regime shift âWeâve exercised the muscle of pushing inflation down for so long that changing direction feels unnatural. But that is exactly what we will need to do.â
2021 BEGAN WITH THE WORST FIRST QUARTER FOR INVESTMENT-GRADE BONDS SINCE 1980. HOW ARE YOU FINDING OPPORTUNITIES FOR THE WEITZ FIXED INCOME PORTFOLIOS?
TOM: To backtrack a bit, the broad corporate bondmarket ended 2020 with duration â or interest rate sensitivity â at a 20-year high. At the same time, forward returns, as measured by yield-to-worst, were at an all-time low of 1.75%. So, it didnât come as a big surprise to us that corporate bond investors had a rough quarter.
But the real culprit was Treasuries. As the economy showed signs of growth, 10-year Treasury rates doubled, and 30-year rates increased by nearly a full percent. With such a large price impact to Treasuries, all sectors â including corporate bonds â took a hit.
NOLAN: The first quarter of 2021 was a great exampleof why we embrace an active, flexible approach to fixed income investing. Our portfolios invest in a wide variety of assets, including securitized assets like asset-backed securities as well as an area we have been intently focused on during the past year â corporate collateralized loan obligations, or CLOs. These are typically shorter-duration or floating-rate products, and in the current bond market environment, CLOs have typically offered higher yield than similarly rated corporate bonds. Securitized assets arenât particularly well-represented in indexes because many donât meet the criteria for inclusion. This is why it can be beneficial to have the flexibility to search for opportunities beyond the index.
Our investing approach is to construct portfolios one security at a time, sector by sector, based on what we believe are the best risk/reward opportunities available at the time. We believe that a disciplined approach to balancing risk and return is how active managers can help investors navigate through a rising rate environment.
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