Treasury yields have recently surged, with the 30-year bond nearing 5.31%. Despite market volatility, opportunities for income-seeking investors are emerging, particularly in the intermediate and front end of the yield curve. Experts suggest diversifying portfolios with high-quality bonds, non-U.S. debt, preferred securities, and TIPS to capitalize on higher yields and hedge against market risks.
The bond market experienced significant turbulence last week, marked by a sharp increase in Treasury yields and a planned intervention by the Treasury Department. The yield on the 30-year Treasury bond briefly exceeded 5.31%, its highest point since 2007, while the 10-year note surpassed 4.7%. This surge in yields, which moves inversely to bond prices, particularly impacted long-dated bonds due to their sensitivity to interest rate fluctuations, a concept known as duration.
In response to the sell-off in long-dated bonds, the Treasury Department announced it would more than double its government bond purchases, focusing on the long end of the yield curve. This move provided some temporary relief to the fixed-income market. Paul Olmsted, principal in fixed income strategies at Morningstar, attributed the rise in long-term yields to several factors, including the national debt climbing to $40 trillion, a substantial issuance of corporate bonds to fund the artificial intelligence buildout, and ongoing inflation concerns.
Olmsted highlighted the benefits of higher yields for investors, stating, "As much as I like to say, 'Own higher yields,' you can do it in a way that just benefits bondholders for the long term." Yields saw a slight retreat on Tuesday as oil prices cooled, with the 30-year Treasury bond yield falling to 5.176% and the 10-year yield dropping to 4.643%. Wednesday saw yields tick up modestly.
Strategic Opportunities in Fixed Income
While long-dated Treasurys experienced the most pronounced yield increases and subsequent price declines, the intermediate portion of the yield curve presented attractive opportunities. Brad Collins, senior fixed-income client portfolio manager at Vanguard, noted, "We are finding opportunities across the yield curve and would pivot focus toward the front end and intermediate part of the curve," specifically mentioning maturities between one and 10 years.
Vanguard's active managers are focusing on building portfolios with a "high-quality carry" and have identified opportunities within the banking sector, as well as in mortgages and asset-backed securities. Similarly, Olmsted pointed out that the duration found in the core bond space, which is typically intermediate-term, also serves as a valuable diversifier against stock market volatility. "If things are really going south, you can still put money in Treasurys and earn what is really good yield," he added, noting that 5-year and 10-year notes, along with front-end offerings, provide compelling yields above 4% and can offer downside protection.
For investors seeking intermediate duration exposure, the Vanguard Core Bond ETF (VCRB) offers a 30-day SEC yield of 4.88% with an expense ratio of 0.1%. The Baird Intermediate Bond Fund (BIMIX) provides an SEC yield of 4.43% with an expense ratio of 0.3%.
Diversification and Hedging Strategies
Donald Calcagni, chief investment officer at Mercer Advisors, suggests that diversification beyond U.S. debt is prudent, especially given the potential for continued erosion in the U.S. dollar's value. He recommends looking at non-U.S. debt and broader non-U.S. assets. "There is value to diversification that we think makes sense."
Calcagni advises a diversified approach, avoiding below-investment-grade issues and concentrating on developed markets. He also favors preferred securities and Treasury Inflation-Protected Securities (TIPS). For income-focused investors with specific cash-flow needs and time horizons, liability-driven investing (LDI) can be a strategic tool. This involves purchasing bonds with maturities that align with future cash outflows, effectively hedging out future cash flows. "Many retirees can do the same thing; you're hedging out future cash flows," Calcagni explained. "It's easier to do that when you have a higher rate environment."
