This podcast features a retirement-focused discussion on core plus fixed income, its foundational role within portfolios, and timely events impacting long-term prospects for the asset class. Janet Rilling, senior portfolio manager and head of Allspring Plus Fixed Income, speaks with Cara Magliocco, defined contribution investment only specialist, and provides her insights on this topic.
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Cara Magliocco: I’m Cara Magliocco, defined contribution investment only specialist with Allspring Global Investments, and you’re listening to On the Trading Desk®.
Today, we’re having a retirement-focused discussion on fixed income and the role it should serve within portfolios. We’ll cover the foundational nature of core plus fixed income and the impact of timely market events on the long-term prospects of the broad asset class, elements which are vital to successful retirement investing.
Joining us today is Janet Rilling, senior portfolio manager and head of Allspring Plus Fixed Income, who will be providing her insights on this topic. Thanks so much for being here, Janet.
Janet Rilling: Thanks, Cara. I’m happy to be here.
Cara: Great. Following a year where the Bloomberg U.S. Aggregate Bond Index produced a negative return for investors, why does fixed income still make sense for those individuals planning for or who are already in retirement?
Janet: Well, no one likes to see negative returns in their portfolio. I think it’s important to put this all into context.
If you step back over a market cycle, fixed income can serve as a ballast in one’s portfolio. It has a different return profile than other asset classes, with an obvious example being stocks. That diversification benefit can help dampen volatility and improve risk-adjusted returns over a cycle.
Certainly in the short term, correlation between asset classes can increase, and looking at the current environment, we see that the factors that are negatively impacting fixed income, such as the Fed (Federal Reserve), rising interest rates, inflation, and the geopolitical risk have also impacted stocks.
But looking specifically at bonds, that increase in rates has led to a repricing. Yields have now been set higher and, in fact, are well off the lows of the cycle. The adjustment to get here has been painful, especially since the move has been quick, but the silver lining to rising rates is that as a saver, you can reinvest at a higher yield.
The higher yield also serves another important purpose in the portfolio, and that’s the steady income component. That income can help buffer declines caused by future increases in rates.
So the higher starting yield, the more of this protection an investor has, and that’s what makes fixed income an important foundational allocation in a portfolio—the prospect for both income and capital appreciation.
Cara: Great. Building on your comments around fixed income’s foundational qualities, can you talk about how this idea of “foundational” within fixed income is applied across the universe of managers offering up core and core plus solutions?
Janet: When I think about foundational fixed income allocation, I envision a portfolio that’s constructed to generate a return that is correlated with the broad fixed income market. As a point of reference, a common standard measure for the fixed income market is the Bloomberg Aggregate Index.
But to take it one step further, a good core or core plus solution should not only provide that foundational return stream, but also include additional return to outperform a passive allocation. As an active manager, you can do that by favoring some fixed income sectors over others. For a core plus strategy, like the one my team manages, there are lots of ways to do that.
One option is a perpetual tilt to certain sectors with the idea that carry over the cycle will lead to outperformance, but this static approach can lead to more volatility. We instead implement a lever approach, meaning we look to dial up or dial down exposures across a wide range of decision planes in fixed income.
At the highest level in the portfolio, that means tactically shifting to the areas of the market that present the best risk/return profile. So, at times, that means increasing an allocation to the plus sectors, such as high yield and emerging markets. But in other market environments, it means pulling in the reins and taking advantage of a more defensive posture by favoring investment-grade sectors, like corporates and structured product.
Using this approach, we can tilt the portfolio to more income and return sectors when valuation is attractive but dial them back when the market gets expensive. You can think of this really is the opposite of a “set it and forget it” approach. It allows the portfolio to benefit for opportunity in a range of market environments.
Another tool worth mentioning that we rely on is diversification. We look to generate alpha from a range of exposures. In other words, not relying on one particular sector or issuer in the market but rather getting our performance from a wide range of decisions. We can think about this as the common expression of not putting all your eggs in one basket.
And then the last piece of the puzzle, in my mind, is security selection. Good research and issue selection provides an opportunity for a portfolio to outperform the market in really any type of environment. That’s a lever that we rely on quite heavily.
Cara: Thanks so much. Short-term dynamics often create volatility that can be used to build better portfolios for the long term. How are geopolitical circumstances or central bank actions helping your team to strengthen the foundation of your portfolios for 2022 and beyond?
Janet: Just like a successful athlete, I believe it’s what you do in the offseason that best prepares you for the big event.
In our case, I look at 2021 as a bit of the offseason. While there was some rate volatility, we saw a high degree of calm across the credit markets. During the first half of the year in particular, we saw credit spreads move in a pretty smooth fashion tighter. So our offseason preparation consisted of gradually reducing risk in the portfolio and then remaining patient in the early parts of this year.
So far in 2022, we’ve seen a material repricing in credit spreads and elevated volatility. But in our view, that move is not largely out of line, given the change in the global macro picture. We’re now dealing with increasing inflation, downward pressure on growth, and heightened geopolitical risk.
As a team, we’re watching this all closely and have dipped our toe in a little bit in terms of credit exposure, but for the most part we are being patient before we bring it up further.
On the duration front, we’ve taken a tactical approach, which is in contrast to last year when we were more strategic. Our center of gravity is a neutral position, and then when rates move beyond what we think makes sense, we take a modest duration or curve exposure to take advantage of it. We’re not hanging out long in any particular position here, though. Once rates get back to our target, we move the portfolio position back to neutral and then we sit tight again until we see another outsized move.
So thinking forward this year, we expect to continue this way until we either get a bigger repricing in the market or a substantial change to the macro view.
Cara: Taking your comments just one step further, can you talk more specifically on how the Russia/Ukraine situation is impacting global fixed income markets, as well as your team’s portfolios?
Janet: Certainly from a humanitarian standpoint, the situation is devastating. As it relates to the markets, it’s made the Fed’s already difficult job even more challenging.
Coming into this year, the central bank was put in a position to find the right balance between implementing rate hikes to control inflation but not choking off the economy. Add in a war, along with its accompanying inflation pressures, and the challenge just grows.
A direct impact of the war has been downward revisions to global growth estimates. Supply chain pressures have grown, especially as it relates to commodity sectors, and that serves as a drag to the global economy.
While it’s too soon to know how much impact we will see on credit quality, it’s probably safe to say that we are past the easiest part of the cycle and corporate earnings will be more challenged in the quarters ahead.
As it relates to the global fixed income markets, Russian securities have seen the biggest price declines as repayment to bondholders is in question. We’ve seen European credits soften, as well, given its more direct exposure to the conflict.
Another big mover, but in the other direction, has been oil and commodities. As a result, bonds issued by energy companies have been an outperformer, while those sectors which are consumers of energy and other commodities have been under increasing pressure.
All of this serves to remind me of the value of diversification, a topic we touched on earlier. Higher exposure in the riskier geographies and sectors can begin to dominate a portfolio’s performance in times like these. Having more modest-sized exposures helps to dampen the impact when volatility strikes.
Cara: Thanks for that. As plan sponsors and consultants help build out investment policy statements, a key consideration most certainly is downside investment risk. How are core plus fixed income managers equipped to address this and drive for consistent risk-adjusted results over time?
Janet: The benefit of a core plus allocation is that it starts with a yield advantage. By allocating to sectors outside of the core, which are defined as the investment-grade fixed income sectors, to places like U.S. high yield, European credit, and emerging markets, the portfolio can tilt toward higher income, which can serve to blunt the impact of rising rates.
In improving economic environments, the returns will also likely benefit from spread tightening. In a risk-off scenario, however, these lower-credit-quality securities can underperform, so it’s helpful to look for a manager that is tactical and looks to reduce exposure to these sectors when valuations are less attractive.
Cara: While some plan participants might view fixed income as a “set it and forget it” asset class, we know that fixed income markets are inefficient. Why is an active approach within fixed income vital for long-term success from this allocation?
Janet: Over the years, I’ve seen numerous examples of inefficiency in the fixed income markets. To me, that is a strong argument of why an active fixed income manager can add value.
Take the most recent dynamic as it relates to the market benchmark, the Bloomberg Aggregate. It is extended to near its peak in duration terms. At the same time, it’s provided a yield that’s below the last 20 years.
So the investor, if they take a passive allocation, is being asked to take on the most duration risk for below-average yield. And so the question I ask is why would one want to passively accept that?
An active approach can rotate out of the most rate-sensitive areas and look to diversify yield. It can move the portfolio to places like the spread sectors, which include U.S. high yield, and some of the areas outside of the U.S., like European credit and emerging markets.
Also, given all the crosscurrents that we’re seeing in the current market, I think it makes a lot of sense to be tactical, to rotate those exposures and not to have perpetual overweights to certain parts of the market.
And then lastly and importantly, I’ve already touched on security selection. That’s a really important technique for outperforming the market. In any market environment, there are securities that are outperforming the benchmark and those that are underperforming.
We have a strong research team that’s good at picking credits. They look for ways to exploit mispricings or finding good value for the risk taken. So that ends up being a lever we rely on pretty heavily to actively manage a portfolio.
Cara: Great. In our final minutes, what do you think is most important for fixed income investors to keep in mind while building and managing their retirement portfolios going forward?
Janet: Fixed income can provide ballast in a retirement portfolio, but it is also a place where being passive or setting and forgetting it can work against the investor.
If the investor doesn’t want to think about these decisions—in other words, when to move from emerging markets to high yield to investment-grade—a good solution there can be to allocate to a manager that structures the portfolio to be foundational but is also tactical and will shift the portfolio allocations to the area of market opportunity.
Cara: Great. Thank you so much, Janet, for being with us today and for sharing your insights.
Janet: Thanks, Cara. It’s been great to be here.
Cara: Well, that wraps up this episode of On the Trading Desk. If you’d like to read more market insights and investment perspectives from Allspring Global Investments, you can find them at our firm’s website, allspringglobal.com.
To stay connected to On the Trading Desk and listen to past and future episodes of the program, you can subscribe to the podcast on Apple Podcasts, Spotify, Google Podcasts, or whatever podcast subscription service you use. Until next time, I’m Cara Magliocco and thanks so much for listening.
Disclosure: All investing involves risk, including the possible loss of principal. There can be no assurance that any investment strategy will be successful. Investments fluctuate with changes in market and economic conditions and in different environments due to numerous factors, some of which may be unpredictable. Each asset class has its own risk and return characteristics. The Bloomberg U.S. Aggregate Bond Index is a broad-based benchmark that measures the investment-grade, U.S.-dollar-denominated, fixed-rate taxable bond market, including Treasuries, government-related and corporate securities, mortgage-backed securities (agency fixed-rate and hybrid adjustable-rate mortgage pass-throughs), asset-backed securities, and commercial mortgage-backed securities. You cannot invest directly in an index. Alpha measures the excess return of an investment vehicle, such as a mutual fund, relative to the return of its benchmark, given its level of risk, as measured by beta. Alpha is based on historical performance and does not represent future results. Diversification does not ensure or guarantee better performance and cannot eliminate the risk of investment losses.