The Cost of Waiting

Income is doing the heavy lifting again

Higher starting yields have fundamentally improved the return potential of fixed income. Investors can now earn meaningful income without relying on falling yields or tighter credit spreads to generate positive returns. Crucially, that income also provides a cushion against further increases in yields, helping offset mark-to-market losses. This is particularly relevant in today’s environment: the higher the starting yield, the more adverse rate movement a portfolio can absorb before its total return turns negative. For example, a starting yield of 1.6%, as observed in 2021, provides little cushion against rising interest rates. A move of just 40 basis points was enough to push total returns into negative territory. In contrast, the current yield of 5.7% for the same index offers a much larger cushion: yields would need to rise by a further 142 basis points before total returns turn negative.

Moreover, time and compounding work in investor’s favour. Even if yields were to increase 1% tomorrow, the additional income available today helps offset the initial price decline. As coupons are reinvested at higher rates, income generates further income, gradually helping recover the initial mark-to-market loss. The longer the investment horizon, the more powerful this effect can become, which reinforces the case for investing now rather than waiting for the perfect entry point.

Compared with the exceptionally low-yield environment of recent years, the risk/reward equation has improved materially. Waiting for the perfect entry point risks foregoing attractive carry whilst trying to predict a market turning point that may only become clear in hindsight.

Attractive income, without needing to compromise on credit quality

Currently we have high(er) yields together with, in our view, relatively healthy credit, which is a rare and attractive combination. Across much of the investment grade universe, issuers continue to benefit from solid liquidity, manageable leverage and resilient cash generation. Having navigated the pandemic and subsequent tightening cycle, many companies have prioritised balance sheet flexibility and liquidity buffers. Whilst higher funding costs and weaker growth could eventually put pressure on some borrowers, we do not currently need to reach aggressively down the credit spectrum to access attractive yields. Our investment process allows us to be selective rather than opportunistic, with preference for strong issuers, robust business models and transparent balance sheets, where carry can be captured without taking unnecessary credit risk. The attraction is not simply higher yields, but higher yields from borrowers whose fundamentals remain broadly supportive.

The sweet spot: carry today, optionality tomorrow

Our preferred approach is to capture attractive income in high quality short and intermediate duration credit, whilst retaining flexibility to adjust duration as the outlook evolves. Shorter maturities limit sensitivity to another rates sell-off and allow portfolios to earn carry whilst uncertainty around inflation and central-bank policy persists. If yields rise further, we can selectively extend duration at more attractive levels. Moreover, today’s starting yields create an interesting asymmetry for fixed income investors:

•  If demand and growth deteriorate, inflationary pressures should eventually ease, giving Central Banks room to cut rates creating the potential for meaningful capital gains from duration.

•  If demand and growth remain resilient and inflation stays elevated, rates may remain higher for longer but that is not necessarily a bad outcome for fixed income, as investors continue to earn attractive coupons.

In other words, we do not need to call the peak in rates: we can earn income today and position for tomorrow’s opportunity.

Conclusion

In our view, the current environment offers a compelling opportunity to put fixed income back on the map when thinking of strategic allocations. Interesting starting yields, broadly resilient corporate fundamentals and the flexibility to adjust duration at a later stage, create a stronger foundation for returns. Volatility is likely to persist, particularly whilst inflation and energy prices are uncertain, but that volatility can create opportunities to add duration and credit selectively. Rather than waiting indefinitely for the perfect entry point, we favour investing progressively in quality and carry today, whilst preserving the flexibility to capture further opportunities as markets evolve.

Bond prices can fall, income is not guaranteed, and investors may not recover the full amount invested.

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