With bond yields reaching multi-year highs, income investors are finding compelling opportunities, despite market volatility. Experts suggest focusing on shorter-duration and investment-grade corporate bonds, as well as floating-rate instruments, to balance yield enhancement with interest rate risk mitigation.
Strategists recommend building positions incrementally in the five- to seven-year part of the curve for long-term income generation and capital preservation. This approach allows investors to capitalize on current attractive yields while navigating potential rate hikes.
In a market marked by rising interest rates and bond volatility, income investors are finding themselves in a more advantageous position than a year ago, with current yields offering significantly better starting points for future returns. The benchmark 10-year Treasury yield has surged to levels not seen since 2007, reaching 5.179%, while the 30-year Treasury is at a high not observed since 2004, trading at 5.469%. These upward movements in yields are driven by a confluence of factors, including federal debt, higher oil prices, persistent inflation, a robust economy, and the Federal Reserve's ongoing monetary tightening cycle. The market is pricing in a strong likelihood of another rate hike at the Fed's October meeting.
"If you're an investor coming to the market looking for income today, you're in actually a much better position than you were if you had been doing so about a year ago, because your starting yield is much better," noted Rebecca Venter, senior fixed income client portfolio manager at Vanguard. She added that this scenario provides a more balanced outlook for future returns, allowing investors to earn more income on a steady-state basis and potentially mitigate rapid negative returns if rates continue to climb.
Navigating Bond Market Volatility: Strategies for Income Investors
While the extended part of the yield curve is experiencing notable choppiness, experts advise investors to exercise caution due to the higher duration, or price sensitivity to interest rate changes, of long-dated bonds. Venter suggests focusing on shorter-duration assets, typically up to five years, to minimize interest rate risk. Treasury bills remain the safest option due to government backing, but investment-grade corporate bonds can offer a more substantial yield with a manageable increase in credit risk. These offer greater durability of return and yield compared to money market funds, without exposing investors to excessive interest rate risk.
For those seeking attractive yields with minimal interest rate risk, Michael Arone, chief investment strategist at State Street Investment Management, highlights floating-rate corporates in the one- to three-year maturity range. These bonds feature rates that periodically reset, allowing investors to benefit as yields move higher. The State Street SPDR Bloomberg Investment Grade Floating Rate ETF (FLRN), for instance, offers a 30-day SEC yield of 4.02% with a low expense ratio of 0.15%.
Investors willing to assume slightly more credit risk can explore floating-rate bank loans, which are considered below investment grade but can offer yields exceeding 7% in some cases, compensating for the added risk. For a more balanced approach, Omar Aguilar, CEO and chief investment officer at Schwab Asset Management, identifies the five- to seven-year part of the curve as a "sweet spot," particularly for investment-grade corporates, citing strong corporate fundamentals and solid balance sheets across most sectors.
Building Positions Incrementally for Long-Term Gains
Leslie Falconio, head of taxable fixed income strategy in UBS Americas' chief investment office, also favors the five- to seven-year segment for credit assets, but cautions against hasty decisions. "A lot of this is knee-jerk reactions, and they have a tendency to reverse pretty quickly," Falconio warned. She recommends building positions incrementally for longer-term horizons, emphasizing that these allocations are not short-term plays but rather opportunities to secure high-quality income that can compound over time and provide a significant cushion against potential headwinds from rising interest rates.
Within credit, Falconio recommends investment-grade corporate bonds and agency mortgage-backed securities. On the shorter end, she advises sticking with Treasurys and higher-quality high-yield corporate bonds. For a deeper dive into income investing strategies, related articles suggest exploring the impact of soaring yields on the 60/40 portfolio and the evolving opportunities in municipal credit influenced by climate risk.
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