​The Fixed Income Dilemma

Rethinking Fixed Income with a Global Perspective

​The Fixed Income Dilemma
NEI Investments recently released a white paper detailing the steps the company has taken with regards to the design of a new fixed-income fund the company just launched. Over the week to come we’ll get into some of the ideas in the paper. But as prelude, it is worth noting the basic idea that drove the creation of a globally-focused fixed-income fund: A long period of generally impressive fixed-income returns in Canada has come to an end—After thirty years of good returns domestically, it’s time now to go global in terms of fixed income assets.   

The paper quotes some interesting numbers. Over the past twenty five years Canadian fixed-income has delivered an annual return of 7.75%. This compares to annual returns on equities of 8.34%, which is a better performance, but only slightly better.

A basic assumption of markets is that more return accrues to securities that are more risky. That is, stocks usually generate much higher returns than fixed-income. So, how then, did fixed income, achieve almost “equity-like performance?”

The NEI research shows that, since the early 1990s, the yields on bonds have slowly dropped over time. This has had the effect of driving up the price of older-dated bond with higher interest rates attached. Total return on bonds (of all durations), then, has been good. But this period of exceptional performance is also at an end. The bond market in Canada, according to NEI, has hit a floor of sorts. Rates for fixed income are as low as they are going to go. The unique outperformance of domestic Canadian fixed-income is done. Total returns on fixed-income will generally be lower into the future than in the past. Daniel Solomon, chief investment officer with NEI, helped author the white paper."Decades ago, in 1980, was the peak in yield. The interest rates paid on fixed income were double-digit. Since then rates have dropped steadily for decades. They more or less hit a floor about a year ago. Now investors are asking, how do I get a reasonable return from fixed income given the risk?” The answer for those who want to continue to hold fixed income as part of a portfolio is to begin looking globally for returns says Solomon.

"Looking outside of Canada, what you find is a huge diversity of fixed income securities. Canada is 2.7% of the global fixed-income market. But a typical client has 57-70% of investments in fixed income in Canada. We always hear about home-bias in terms of equity holdings. But there is an even bigger bias when it comes to fixed income,” says Solomon. “It is time to consider global opportunities in fixed-income.” 

How it is NEI manages currency risk while avoiding dead spots in global fixed-income markets (Japan)--allowing a fixed-income fund to out-perform global yields that are even lower than in Canada--will be answered over the week to come. Stay tuned for the answer to the fixed-income dilemna!