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The Challenge of Fixed Income Investing in the 2020s

March 10, 2021 / Brief

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Fixed income investing has fundamentally changed in the last decade. Increasingly low interest rates, unprecedented central bank monetary policy, and aging demographics have altered the way investors think about generating income in their portfolios. Forced to weigh low yields, higher risk, and more structured fixed income investments, income-focused investors face difficult trade-offs regarding asset allocation.

The trend of lower yields accelerated and became more entrenched in the 2010s prompting investors to chase higher yields in unconventional ways. However, most high yields come with the trade-off of higher risk in the form of higher volatility and higher principal drawdown. In fact, many leading fixed income indexes reflect this reality even with current yields lower than average trailing 10-year yields.

• Higher Yields • Higher Risk • More Obscure Investments • Lower Yields • Lower Risk
10-Year Average Yields Current Yields Maximum Drawdown 6.00% 5.00% 4.00% 3.00% 2.00% 1.00% 0.00% -10.00% -20.00% -30.00% 5.00% 3.32% 2.54% 1.42% 2.16% 0.92% 0.58% 0.09% - 0.02% Investment GradeBonds High Yield Bonds T-Bills T-Bonds - 19.12% - 16.27% - 17.59% Maximum drawdown is the maximum decline a security experiences prior to reaching its previous peak. As yields rise, so do historical drawdowns. Select Indexes Current and 10-Year Average Yields and Maximum Drawdowns1.1.2011-12.31.2020

High Yield Bonds: ICE BofA BB Yield Bond Index; Investment Grade Bonds: ICE BofA AAA Bond Index; T-Bonds: 10 year U.S. Treasury Rates; T-Bills: 90 day U.S. Treasury Bills Sources: Morningstar Direct, Federal Reserve Economic Data

Rising Interest Rates Hurt More When Yields are Low

Fixed income securities have historically been viewed as an investment that not only generates income, but generally preserves capital, at least far more than equity investments. However, with so little yield generated today, relatively small increases in interest rates can impair total returns. This is true even for the highest quality fixed income investments: U.S. Treasury Securities. A mere 1% rise in rates from current levels would drop the market value of a 30 year U.S. Treasury Bond by over 20%. Impacts could be even worse for lower quality fixed income investments.

Impact of a 1% Rise in Interest RatesAssumes a parallel shift in the yield curve and steady spreads -19.4% -21.0% -8.2% -9.1% -1.8% -2.0% -2.6% -3.2% -4.5% -4.8% Total Return Price Return 2 YEAR U.S. TREASURY NOTE TREASURY INFLATION PROTECTION SECURITY (TIPS) 5 YEAR U.S. TREASURY NOTE 10 YEAR U.S. TREASURY NOTE 30 YEAR U.S. TREASURY NOTE 0% -4% -8% -12% -16% -20% -24%

Source: J.P. Morgan Guide to the Markets, Q1 2021

Negative Yields? They Are Already Here in Real Terms

Record low nominal U.S. Treasury yields have pushed real rates, the inflation adjusted yield, into negative territory. While market observers may fret over potential negative yields, in essence, the U.S. is already there.

1.50% 1.00% 0.50% 0.00% -0.50% -1.00% -1.50% Jan 2016 2017 2018 2019 2020 Jan 2021 Inflation Adjusted Real 10-Year Treasury Yields2016-January 2021

Source: Federal Reserve Economic Data, U.S. Treasury Inflation Adjusted 10 year Note.

Alternatives: A More Palatable Trade-Off?

Current market conditions reveal a simple and challenging reality: with traditional investment options, investors can generate higher income with higher potential drawdowns or they can settle for lower yields and lower drawdowns. However, another option is available with the world of alternative investments. Alternative investment paradigms offer new possibilities which seek to challenge pre-conceived notions about performance trade-offs creating a nuanced advantage in the world of income investing. By giving up intraday liquidity, investors are presented with a host of new investment options that can potentially generate higher yields with lower volatility and drawdown.

Liquidity, while a benefit, can also be a curse of sorts as daily liquid investments tend to draw very large amounts of capital in a short amount of time leading to pricing distortions. These distortions can then lead to the very volatility and drawdown that investors sought to avoid. Less liquid investments tend to avoid these distortions while still generating above market yields broadening their appeal to institutional investors.


This information is educational in nature and does not constitute a financial promotion, investment advice or an inducement or incitement to participate in any product, offering or investment. Bluerock is not adopting, making a recommendation for or endorsing any investment strategy or particular security. All opinions are subject to change without notice, and you should always obtain current information and perform due diligence before participating in any investment. All investing is subject to risk, including the possible loss of principal. The information contained herein is sourced from third parties and Bluerock makes no assurances with respect to its accuracy, completeness or timeliness. Past Performance is not necessarily indicative of future results.