2022 was the worst year on record for investment grade corporate bonds largely due to a dramatic increase in interest rates. With this recency bias and the markets focused on the actions of the US Federal Reserve, many investors have looked to other income producing asset classes as a replacement for their corporate bonds. While these asset classes may have outperformed in a rate hiking event, it is important to remember that these other asset classes have a risk profile all their own during a credit event.
The saying “Cash is King”, popularized by Volvo CEO Pehr Gylrnhammar during the 1987 market crash, has become a rallying cry during periods of market volatility. The premise seems sound, no volatility in times of market turmoil, instant liquidity to deploy capital when pricing seems reasonable, and we all know having cash on hand for private transactions certainly beats the questions that come with check or credit. But is this always the case?
The old joke about economists being created to make weathermen look good has been around for as long as finance and meteorology. To be fair both are very tough professions, trying to predict with a high degree of certainty a force that changes rapidly and affects the lives of many. In an attempt to accomplish that feat, both professions have poured the most significant advancements of theory, science, and technology into their practice, trying as they might to keep the next market correction / rebound or natural weather disaster / beautiful sunny day from being a surprise. As we know all too well, this unfortunately doesn’t always work out, and we are sometimes left on the wrong side of the trade or soaking wet on the golf course.
As time goes by, the need for balance in our lives becomes increasingly important. We must maintain a work – life balance to take care of career, family, and self. We need to maintain a balanced budget to make sure we prioritize what we want, what we need, and what we must save for the future. And of course, we need a balanced diet to curtail eating some of the comfort foods we love to ensure health and longevity. It’s a balancing act worthy of the Flying Wallendas.
The same could be said for our investment portfolios. The idea of optimizing a portfolio to maximize return based upon an investor’s comfort level with risk is as intuitive as balancing your checkbook, or your diet. It can also present similar challenges. Often investors will look to abandon their fixed income allocations when yields are low, when they think rates are set to rise, or when outsized opportunities for gain and/or higher yields present themselves in other income producing investments.
There are many reasons that an investor may employ a professional bond manager. One of the most important considerations when working with a professional bond manager is its access to institutional trading desks and its ability to purchase bonds at a fair or attractive price. Many investors are aware that equities are exchange traded, which allows investors to easily buy or sell equity securities with relatively low transaction costs.
It may no longer be true that “bigger is better” when picking a corporate bond manager. After the financial crisis, reforms to cut global risks have changed some basic features of the corporate bond market. Bond market volumes are healthy and exceed levels of 2007, but the average bond transaction is 40% smaller today.
As a Corporate Bond Manager we often receive inquiries regarding our thoughts on the Bank Loan Market especially in the current interest rate environment where the 10-year US Treasury Bond yield has increased 1% over the last 9 months. We believe that the asset class may warrant a place in an investor’s asset allocation and complement other credit sectors such as Investment Grade Corporates and High Yield but we suggest exercising caution, as all loans are not created equal.
It is common for individual fixed income investors to construct portfolios utilizing a “ladder” strategy, purchasing bonds over a specific time frame, 5 or 10 years for example, and in equal installments – an issue coming due each calendar year. This approach is fairly straight forward; however, we find that investors pursuing this type of strategy give up potential return.