The traditional role of fixed income within an investment portfolio is two-fold: it aims to offer attractive yields to investors and preserve capital in times of market volatility. When markets face downside risks, fixed income should “show up to work” by offering stability against the volatility experienced in other asset classes within an investment portfolio.
Historically, fixed income has delivered on this role. If we look at how US and Canadian government and corporate bonds (also known as Core bonds) have performed during the past six recessions, we can see that peak-to-trough declines in returns are much smaller with fixed income than with equities. For example, the average drawdown for Core Canadian bonds over the last six recessions was 4.1%, versus 30.1% for Canadian equities.
Coming out of recessions, fixed income markets have produced attractive annualized returns in the three years post-recession, sometimes in excess of equity markets. For example, over the last six recessions Core Canadian bonds produced, on average, a 9.2% 3-year annualized return post-recession, while Canadian equities produced 11% on average, but with much larger downside risks.
In addition to Core bond markets, investors should also consider the benefits of owning Plus fixed income securities in their investment portfolio. Plus fixed income can be broken down into two key areas: structural fixed income and hybrid fixed income. Structural fixed income offers highly structured, secured debt instruments such as securitized bonds and mortgage strategies. These bonds can be produced from many different pools of lending products such as government-guaranteed mortgages, auto loans and credit card debt. They usually provide attractive income streams for investors and less fluctuation during market volatility, due to their highly structured nature.
Hybrid fixed income has elevated credit risk, but the overall risk is still lower than equities. Hybrid fixed income options can include non-investment grade debt, private credit and leveraged loans (PDF, 490 KB) Opens in a new window.. These assets generally have lower interest rate risk than Core bonds and benefit from higher positions in the capital structure — resulting in lower volatility than equities. As an example, high-yield experienced an average drawdown of 18% over the last six recessions.
As experienced through the past six recessions, fixed income has delivered on its role of preserving capital and providing less volatility than equities. It has also shown attractiveness coming out of recessions with equity-like returns. For the inevitable coming recession, we believe fixed income continues to offer key roles of capital preservation and is a source of attractive return.
