tive real interest rates are a problem for fixed-income investors . It ’ s destructive to purchasing power .”
Dow ’ s recommendation to clients in the fall of 2020 was to reduce fixed income , add inflation hedges ( real estate , commodities , equities , Treasury Inflation-Protected Securities ) and look for risk premiums outside the public markets in alternatives , he says . But that was then .
“ Now it ’ s April of 2022 , and the Federal Reserve is going to raise interest rates until they can gain control of inflation expectations . We ’ re hearing a lot from clients about TIPS , but now is not the time to own TIPS . The price of TIPS already included the price of high inflation , so they won ’ t outperform nominal bonds ,” he says .
Instead , Beacon Pointe is staying neutral-risk given the uncertainty of recession , and Dow says he recommends staying intermediate for fixed income .
“ Natural resources and TIPS have had their time to shine , but that ’ s over . For an afternoon , high-yield corporate bonds looked good in the recent selloff , but prices recovered quickly . Right now we ’ re favoring alternatives , specifically private credit , equity and real estate investments ,” he says .
According to Capital Group ’ s Steinbach , it generally can be helpful to look at past inflationary environments and historical routes of action to guide investments on the fixed-income side of a portfolio .
Capital in Chicago , has been taking a third approach . “ Bonds diversify a portfolio but not over a quarter . They diversify over five years , or 10 years . In an environment of rising interest rates , any maturity you get back you reinvest at a higher rate ,” he says .
The two main drivers Dmytryszyn looks at , besides yields , are interest rates and credit spreads . He says he doesn ’ t feel like the market is compensating for interest rate risk , and it ’ s the credit fundamentals he ’ s more concerned about .
“ Spreads have widened , but not all that much ,” he says . “ If margins come down , does that change things ? Right now we haven ’ t seen that , but we ’ re watching .”
Looking at the big picture , Dow says he expects interest rates to rise pretty dramatically in the near future , even if the Fed risks causing a recession .
“ But things are really different this time . The Fed ’ s balance sheet is bigger than it ’ s ever been . There is significant stimulus in the system ,” she says . “ We ’ re really in an unusual time where everyone is focused on higher inflation rates and fixed-income underperforming .”
That inflation is going to persist well through this year , she says , and supply pressures won ’ t be abating either . To protect against this , Steinbach is looking at relatively short duration positions while waiting for the yield curve to flatten , and being cautious about credit risk .
“ In high yield we ’ ve found more opportunities , but pricings are changing . Interest rates have completely repriced , and we expect the Fed will have to hike rates to combat inflation that will run higher and longer ,” she says . “ This is where investing with an active manager can help . You need to own fixed income and you need to own duration in order to have a balanced portfolio .”
Meanwhile , Matt Dmytryszyn , a CFA and chief investment officer at Telemus
Instead , Dmytryszyn says he ’ s more interested in bonds now than he was at the beginning of the year . “ You ’ re at least earning more income on the portfolio to cushion against the higher yields .”
Looking at the big picture , Dow says he expects interest rates to rise pretty dramatically in the near future , even if the Fed risks causing a recession .
“ They ’ ll do it because it took them 40 years to get here , to establish themselves as the world ’ s best inflation-fighting central bank , with credibility second only to the former German Bundesbank ,” he says . “ During the ’ 80s , the Fed tipped the economy into recession several times in order to anchor inflation expectations near 2 %.”
The late cycle is the worst time to be an asset allocator or investor , he acknowledged .
“ This doesn ’ t sound exciting , but having a diversified portfolio is the best protection an investor can have right now ,” he says . “ And know that in the short run , we ’ re going to see volatility . Volatility is the price we pay for building wealth .”
may 2022 | financial advisor magazine | 59