Fixed-Income Investing at the End of Time (or at Least at the End of the Business Cycle)

By
Kathleen C. Gaffney, CFA

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Kathleen Gaffney, CFA, Eaton Vance Management’s co-director of investment-grade fixed income, used a demographic narrative to weave a tale of contrasts at the 67th CFA Institute Annual Conference in Seattle. On the one hand, she noted, we all have memories of the bucolic 1950s, an imagined time of plenty. On the other hand, we are witnessing a world that some have only half-jokingly called “the end times.”

Some of our wants, such as the cost of housing or an education, were much better priced in the 1950s than they are currently, she said, whereas such necessities as food and clothing are today much cheaper. The point of her lengthy fact-marshaling was to provide needed context (i.e., that the world is not, in fact, ending but rather that every era has its economic challenges). Still, she believes it is the end of a business cycle. And let’s face it, if you are a fixed-income manager, how artfully and delicately the US Federal Reserve handles The Taper is just one minor concern.

The list of unknowns is extensive these days. What about the emerging markets retreat? What about Russia’s recent moves that seem to be making markets look like its mascot, the Bear? And on and on with the cycle of news spin. . . .

So how does Gaffney recommend that investors move from the nausea of the spin to a grin? First, map the current fixed-income landscape, taking account of the fact that at the end of a business cycle, fixed-income investors thirst for:

  • Attractive income . . . even though yields have risen, it’s not over!
  • Good relative value, even though spreads have narrowed.
  • Assets with a low correlation to US Treasuries.

Gaffney believes that there are still specific securities out there that are good credits and that are mispriced. She also recommends that fixed-income investors avoid unwanted interest rate risk and instead swap it for credit risk. In other words, do your homework! Due diligence = getting your due.

Diversify as much as you can and in almost every way, if you can. Gaffney advocates buying developed and emerging market debt, as well as investment-grade and high-yield debt. She also likes traditional fixed-income securities, convertible securities, preferreds, floating-rate notes, and munis. She advocates buying the United States and many other countries as well.

“Great,” you might say, “but could you be more specific?”

Gaffney did provide some guidance with respect to her global outlook:

  • The United States is lead dog in the global business cycle, as growth has ramped up a notch.
  • Mexico and Canada should benefit from US expansion.
  • In Europe, austerity is over.
  • China experiences slower growth as it moves from a production-led economy to a consumption-based economy.
  • Japan: How long can its beggar-thy-neighbor policies continue?
  • Australia: Build a position as an inflation hedge, but buy on weakness.
  • The Fragile Five (India, Indonesia, Brazil, Turkey, and South Africa): Beware these countries’ intense elections.

What would help the hurt currently experienced by fixed-income investors? What would ease the transition from the end of the post-crisis environment into a new phase of strength? The answer is economic growth, pure and simple. This is, alas, the only salve for all fixed-income investors contending with the strong, and perhaps growing, storms that are resulting from a confluence of factors:

  • global economic imbalances between nations;
  • aging societies in many economically important countries; and
  • increased financial regulation.

Please note that the content of this site should not be construed as investment advice, nor do the opinions expressed necessarily reflect the views of CFA Institute.

Photo credit: W. Scott Mitchell

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