Make the most of your fixed income

With international economic uncertainty, many investors are looking to set course for fixed income – but there are still decisions to make on where and how to invest

Andrew Willis 31 July, 2019 | 2:25AM

Dark board

With increased stock market volatility from fluctuating energy prices, mixed messaging on interest rate moves, tense global trade talks and spontaneous tweets from a world leader, investors are looking for stability through fixed income.

What should the fixed income portion of your portfolio look like? We recently talked about why a fee-focused approach makes sense and discussed how green bonds add sustainability to your portfolio. But what else should you look for?

It’s worth watching what the institutions are up to when it comes to fixed income bets. There are many retail avenues that everyday investors can pursue to incorporate some of that institutional edge into your portfolios.

Note: At Morningstar, we encourage investor empowerment, when following institutional trends for a retail portfolio, we suggest partnering with an advisor to help with allocations and balancing your portfolio to help navigate macroeconomic uncertainties and cycles, which are not fixed.

What are the big players doing?

“Our institutional fixed income clients are increasingly moving toward core-plus strategies,” says Leith Wheeler fixed income portfolio manager Ben Homsy. Core-plus plays are often fixed income funds (many available to retail investors) that sprinkle in some alternative debt strategies such as high-yield, global and emerging market debt onto a core portfolio of investment-grade bonds. These strategies allow for the stability of a fixed income bet, while capturing some of the upside to help avoid the risk of a relatively low return from rising inflation.

Diversifying within your debt is an important consideration and strategy to offset the additional risk with a variety of income streams. Homsy’s research recently found that the majority of core-plus premium returns can be attributed to corporate credit, in particular sub-investment grade credit. If you’re okay with a little more risk, supplementing a core bond portfolio with a diversified blend of corporate bonds that might have lower credit rates can serve as a calculated boost to your yield.

If you are more risk-averse, you could follow the capital preservation approaches of pension institutions, whom Homsy suggest consider real return bonds,  “we think that real return bonds, which imply a breakeven inflation rate of 1.38% (versus the Bank of Canada’s 2% long-term target rate), represent excellent value.”

Add some preferred shares for flavor?

Fancy a bit of equity in your fixed income? Preferred shares don’t retain voting rights, but they have priority over common shares when it comes to a company’s income, and dividends.

Leith Wheeler high yield fixed income manager Dhruv Mallick mentions that now might be a good time to buy preferred shares, given their potential recovery from last year’s equity dip. “Given the routing that preferred shares have taken over the past year, for taxable clients we have been adding to our [preferred shares] of late,” says Mallick, who’s been supplementing the four-star rated Leith Wheeler Income Advantage Fund and three-star rated Corporate Advantage Fund with preferred shares.

However, it is relevant to highlight that preferred shares are risky and are not a bond substitute. “We think that some investors became complacent with (and perhaps forgetful of) the risk - but had a sad awakening when all equity markets tumbled late last year,” says Mallick. While common shares rebounded, preferred shares did not.

Fixed is not without risk

Whether the bond is investment grade, the shares are preferred, or the loan is secured, Mallick recommends that investors consider where they stand on the risk spectrum when getting strategic with your fixed income. “Bonds can lose money at certain points in the cycle,” says Mallick, while “in practice the premium yield offered by sub-investment grade debt, for example, can help keep absolute returns in the black, even when rates are falling along with bond prices.”

Mallick mentions the role of the investment manager’s credit analysis and portfolio construction, which can help mitigate the effects.

Finally, can you go green?

Institutions are eyeing green bonds for their sustainable revenues and international support from major international treaty organizations like the World Bank. There are opportunities for retail investors to follow their path as well.

“Retail investors may be able to invest in green bonds by looking for ETFs or mutual funds that include green bonds,” says Radi Annab, Vice President, Project Finance and Global Corporates at credit rating agency DBRS.

Annab cautions however that where institutions have the advantage of resources to conduct in-depth due diligence on the sustainability of their investments, retail investors can only trust that their money going somewhere green. “The challenge is still that a single global standard defining green bonds does not yet exist,” says Annab, “which means that for a retail investor there is no visibility to guarantee that a bond complies with either the Green Bonds Principles or Climate Bonds Standards, the two main frameworks that assess the “greenness” of a bond, or with any other framework.”

With institutions having the head start on green bonds, retail investors may also find little supply left. “The recent keen interest in green bonds and ESG generally, is largely driven by institutional investors as they work on building their ESG credentials, a fast growing trend,” Annab adds. “As such, there is huge demand but supply is not keeping up. This may limit the potential for retail investors, until the market supply catches up.”

Securities Mentioned in Article

Security NamePriceChange (%)Morningstar Rating
Leith Wheeler Corporate Advantage F9.72 CAD0.15
Leith Wheeler Income Advantage Sr F10.37 CAD0.48

About Author

Andrew Willis

Andrew Willis  Andrew Willis is a content editor for Morningstar.ca.