As the bond bull market has been running for nearly 40 years and U.S. interest rates hover near record-low levels, investors of all varieties are questioning the viability of the traditional 60/40 portfolio. Do the diversification benefits of bonds offer enough value in a zero-interest-rate world? Will Treasury yields join European and Japanese government debt and cross the zero lower bound during the next episode of market and economic stress? What other asset classes offer the potential for higher returns while still protecting on the downside?
The relationship between stock and bond returns has been variable over time or, in statistical terms, has exhibited positive and negative correlation depending on the environment. However, throughout history, U.S. Treasuries have consistently delivered on their reputation as a safe haven asset during periods of market stress — when investors most need diversification.
Treasury bond performance shined again this year as the coronavirus pandemic forced a national shutdown and equity investors suffered through the fastest 30% decline on record. As risk markets melted and investors rushed to safety and liquidity, 10-year Treasury bonds generated a first quarter return of more than 11% — which was even more impressive in light of 10-year yields starting the year below 2%.
While the search for bond alternatives has yielded answers ranging from Bitcoin and gold to hedge funds, I believe balanced strategies represent an area where investors can source attractive income and total return characteristics, versus core fixed income. Balanced strategies that have the flexibility to invest opportunistically across a company’s entire capital structure are well positioned to find attractive value in today’s zero-rate world, where more than half the companies in the S&P 500 Index pay dividend yields in excess of the average corporate bond yield.
PMAM’s balanced income strategy seeks to invest in a combination of dividend-paying equities and high-conviction fixed income ideas, including nontraditional areas like convertible bonds and preferred stock. We primarily focus on “self-funding” companies — which generate strong free cash flow without relying on the capital markets to survive. Our emphasis is on lower downside capture combined with positive alpha from security-specific stock and bond selection to generate attractive risk-adjusted returns.
I believe core fixed income sectors like Treasuries and highly rated corporates will remain the most effective diversifiers to risk assets in any interest-rate environment. However, looking beyond core fixed income for a portion of the traditional 40% bond allocation should add long-term value for investors.
Past performance is not indicative of future results. Investors should be aware of the additional risks associated with investments in non-diversification, undervalued or overlooked companies and investments in specific industries. In addition, investors should be aware of the additional risks associated with investments in non-investment grade (high yield) debt securities and structured securities, which are subject to greater fluctuations in value and risk of loss of income and principal as a result of interest rate risk and economic risk. There is no guarantee that dividend-paying equities will pay or continue to offer its dividends. Diversification neither assures a profit nor eliminates the risk of loss.
The information herein does not constitute investment advice and the strategy described may not be available to, or suitable for, all investors.