Why it’s time to shift fixed income strategy

The head of Canadian fixed income at BlackRock explains how investors can navigate the changing fixed income market

Why it’s time to shift fixed income strategy

Although The Bank of Canada decided to stick with its interest rate of 0.5% earlier this week, statements from the bank hinted they may soon be ready to hike rates. Regardless of when the Bank of Canada does raise rates, the 35 year period of falling interest rates – a secular bull market for fixed income – is over and it’s creating challenges for investors who had been riding the fixed income wave.

“We think the secular trend for falling interest rates is over and that we will be in a period of rising rates going forward,” says Aubrey Basdeo, Head of Canadian Fixed Income at BlackRock Canada. “We’ve seen the U.S. start to lead this change and while there is a divergence in monetary policy between the U.S. and the rest of the world, we think in time the rest will do the same thing."

Generating decent income was relatively straight forward during fixed income’s prolonged bull market. Investors were able to passively take on as much interest rate exposure as possible to achieve strong total returns, but, in the new environment of rising rates, investors cannot expect to achieve the same returns.

“Going forward, in the rising interest rate environment, investors will need a better balance of spread risk because it’s negatively correlated with interest rates,” Basdeo says. “This will also require investors to think about being more tactical and active management is going to be more helpful than a passive approach. The primary challenge for fixed income investors will be the need to rebalance the portfolio’s exposures to spread risk and interest rate risk.”

It’s not going to be as simple as allocating more to spread risk, however, and Basdeo does believe the market will experience secular trends. These retracements may create opportunities for a heavier interest rate tilt. “If the China story really goes awry – if there is a significant slowdown there – you could see investors leave risk assets for safe assets like fixed income,” Basdeo says.

Despite the shifting landscape, Basdeo doesn’t believe the role fixed income plays in a portfolio has changed too significantly. “Fixed income provides benefits of diversification and it dampens volatility. It provides a counterbalance to equity exposure – the riskier part of a portfolio,” Basdeo says. “It’s also still important for investors looking to generate predictable income from their portfolio. Capital preservation becomes more critical as people get older and look to reduce their risk by allocating more to fixed income.”