Why Fixed Income Investing Might Be Right for You Today

In this interview, Fixed Income Portfolio Manager Carlton Davis explains how adding fixed income to your investment portfolio can help you weather market volatility.

What is fixed income investing, and what role does it play in wealth management?
Fixed income investing seeks to deliver predictable income while preserving capital. At its core, it’s a loan — a bond — to an entity where an investor provides capital in exchange for regular interest payments. Common examples include municipal bonds, corporate bonds, U.S. Treasury securities and asset-backed securities. Fixed income investments can provide stability and income, helping to smooth out the volatility of riskier markets.

What opportunities do you see in fixed income in the near future?
In the current environment, I believe the fixed income market is poised to deliver attractive returns relative to the broad equity market. Yields are currently at levels not seen since the great financial crisis. I believe it’s unlikely we’ll see yields return to the ultra-low levels of the past decade, which creates an opportunity for higher returns in the future.  Starting yields are a strong predictor of fixed income total returns.

Credit spreads, the additional yield pickup for a corporate bond versus a Treasury bond, have generally moved tighter over the past several years, but the current environment has investors revaluating the trend. Real yields (current treasury yield – expected inflation) have reached levels not seen since before the Great Financial Crisis (2008-2009), providing investors with income well above the rate of inflation. There is also a divergence in global monetary and fiscal policy that may alter asset-class valuations. These factors have led to dislocations in the bond market and provide opportunities for active managers. We are moving into a period where investors should be rewarded for identifying relative value across sectors and individual credits.

Why is fixed income investing such an important tool in uncertain economic times?
It comes down to peace of mind. Fixed income typically offers lower returns than equities — but also significantly lower volatility. That means predictable income when markets are choppy. Even though bond prices can fluctuate day to day, our signature buy-and-hold strategy allows us to focus on the income being generated, not the change in market value due to interest rate volatility. That’s a huge advantage in uncertain economic times — clients can rely on their bonds to mature at par and avoid selling at depressed prices as they might experience with a bond fund or ETF.

Why does Chevy Chase Trust use individual bonds in its portfolios?
Many individual investors buy Bond Funds or ETFs to get broad exposure to fixed income, but we see several drawbacks to this approach.

Funds or ETFs, while a proxy for the market, do not have a predictable income stream and have no set maturity date or value.  Ownership of funds or ETFs may include additional layers of management fees, and the passive approach is exposed to impacts from fund flows and trading decisions. This defeats the purpose of most fixed income strategies.

We believe individual bonds — not bond funds or ETFs — are the best fit for investors. With individual bonds, clients know exactly what they own, when the bonds mature and what income will be generated going forward. This clarity is incredibly useful for planning and managing expenses. Plus, individual bonds are more tax efficient, allowing you to better manage capital gains taxes. We focus on both taxable and tax-exempt bonds and tailor each portfolio to the client’s needs.

How does Chevy Chase Trust’s approach to fixed income differ from other firms?

Our approach combines a focus on the macroeconomic landscape with fundamental knowledge of bond issuer credit and market dynamics.  This allows us to build portfolios based on where we believe the economy and interest rates are headed. We aim to add value to portfolios, not simply take the market return.

We are not a broker-dealer. We do not hold an inventory of bonds that we then sell to our own clients. This allows us to be nimble and focused on where we see value. We buy and sell bonds at institutional prices from a variety of sources, and our clients own bonds at the price we paid, with no markups. We’re always looking for the best ideas for our clients. When a client wants to understand why they own a specific bond, they can connect directly with the portfolio manager responsible for the decision. 

Is fixed income investing only for older investors?
Not at all. While many older investors own bonds because of the lower risk profile, anyone seeking stability, income or lower volatility can benefit. For example, a younger investor who is risk averse or heavily invested in riskier assets may want to offset that volatility with a more predictable, stable investment. Fixed income investing is an exercise in risk management and serves as an attractive asset-liability matching tool. The common thread among fixed income investors is the desire for predictable income and lower volatility — not age or wealth.

What’s the biggest misperception about fixed income?
That it’s boring. In reality, it’s one of the more complex and technical markets. Bonds don’t trade on exchanges the way equities do — we have to source and negotiate every trade. It’s about the strategy, the research and the hunt. Every day we’re digging into economic policy, company and municipality fundamentals and market technicals. It’s incredibly intricate and intellectually rewarding.

Why were you drawn to fixed income investing?
Fixed income forces you to be curious — to constantly learn and understand what’s under the hood. It’s a highly technical, ever-evolving market that keeps me coming back for more. One day I’m looking at new issue corporate bonds, the next day I’m conducting macroeconomic research on updated Federal Reserve policy. I have learned something new every day for the past 15 years and I will continue to learn something new every day for the next 40 years. That’s what I like the most.