Bond investors see opportunity for higher yields

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Have bonds entered another new normal? After more than 13 years of ultra-low yields, 2022 marked a challenging period for bondholders as central banks hiked interest rates at an unprecedented pace to rein in soaring inflation.

Today’s environment for fixed income, with yields exceeding 5 per cent, is a return to a more historical norms for bond yields, says Jean-Francois Girard, manager of investment funds product development at Desjardins.

There were periods of low interest rates and low inflation from the 1930s through the 1950s, and following the 2008-09 global financial crisis. But those are exceptions. “Historically, yields’ typical range was about 3 to 5 per cent, which is more like what we’re seeing today,” Mr. Girard says.

And it looks like these higher yields are here to stay for a while, he adds. “It would not be completely out of the norm to believe that yields will continue in this range.”

A recent DBRS Morningstar report points to stability for at least the near term, suggesting the U.S. Federal Reserve Board may ease its policy rate by a few basis points by the end of 2024.

While nothing is certain, bond yields are more attractive than they’ve been in years. That’s especially so given how volatile equity markets have been. Future valuations for growth stocks appear much less attractive compared with the near risk-free alternative of earning 5 per cent or more annually on a short-term bond, Mr. Girard says.

“History has also shown that when interest rates are at 5 per cent, that is a pretty good indicator of the kind of returns you can expect for the medium term.”

Opportunity may be knocking for bond investors. Yet, many advisors find it challenging to navigate the global fixed-income marketplace on their own. This market is larger than equities, and encompasses multiple types of government and corporate debt, convertible debentures, and securitized debt such as mortgage-backed securities and collateralized loan obligations.

“Just the level of assets needed to get proper diversification in bonds is a difficult feat for investors and their advisors, let alone accessing and finding opportunities in the global fixed-income market, particularly for corporates,” Mr. Girard says.

Many advisors look to bond funds for cost-efficient, diversified exposure for the fixed-income portion of client portfolios. More than ever, actively managed funds can prove their value as the best managers uncover opportunities for outperformance in an environment in which the yield curve is flat or inverted, Mr. Girard says.

He explains that many market observers consider such yield curves to be a harbinger of a recession. “That said, the yield curve has been inverted for some time compared with what we’ve seen in the past.”

At some point, he adds, the yield curve will return to normal, with bonds that have longer maturities bearing higher yields. Yet, for sophisticated fixed-income investors, the current situation presents opportunities to select bonds along the yield curve whose valuations are most likely to benefit when central banks ease interest rates.

Still, these investors must be aware that high inflation could persist, and interest rates could move higher than anticipated, Mr. Girard says. “That’s where active management can help with specialized, risk-adjusted strategies to maximize upside and minimize downside outcomes.”

He notes that a growing number of advisors are looking to Desjardins for its award-winning and actively managed fixed-income strategies¹. Among the more popular choices is Desjardins Global Tactical Bond Fund, a multi-sector strategy with access to investment-grade corporate bonds, high-yield and emerging markets debt.

PIMCO Canada Corp., the fund’s submanager, selects from different bond types, maturities and currencies with tactical asset allocation among the different bond categories. The fund is hedged in Canadian dollars, providing more stability for Canadian investors.

For advisors who don’t want to predict the direction of interest rates but who still want to take advantage of global fixed income, Mr. Girard points to Desjardins Floating Rate Income Fund, a Lipper Award winner in 2023². That fund has a similar mandate as Global Tactical Bond Fund, while aiming to keep its overall portfolio duration as close to zero as possible, Mr. Girard says. “Fluctuations in the Fed’s interest rate increases don’t affect its performance as much.”

Both funds offer access to industry-leading expertise, institutional scale, diversification and opportunities that are often difficult for advisors to uncover on their own. That’s more in demand from advisors seeking defence for client portfolios amid the uncertain economic environment, as well as prospects for outperformance.

“Volatility and cyclical shifts can bring opportunity in the bond market,” Mr. Girard says. “And professional bond managers such as PIMCO, who can access the global markets and make decisions to select the right categories and securities at the right time, are definitely experts who advisors want in their corner.”

¹ Winner of Best Multi-Sector Fixed Income (3 years) at Lipper Awards 2023

² Desjardins | Prizes and distinctions awarded (fondsdesjardins.com)

Advertising feature produced by Globe Content Studio with Desjardins. The Globe’s editorial department was not involved.