After more than a decade of dismal fixed-income performance, with Canadian indexes eking out low single-digit annualized returns, the tides are finally shifting.

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A new era for fixed income is arriving after years of disappointment Back to video

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Interest rates are higher than they have been since the early 2000s and the Bank of Canada recently lowered rates for the first time since 2020, so investors who once shunned fixed income are now racing to take advantage of these tailwinds.

If you read the headlines debating where interest rates will go, you may think that being an expert in macroeconomics and predicting the path of interest rates are prerequisites to successfully investing in fixed income. But nothing could be further from the truth. Not even central bankers know where interest rates will be in the coming years, and it’s often a coin toss as to what will happen in the short term.

The real key to investing in fixed income lies in selecting appropriate fixed-income managers who aren’t bound by the whims of markets and interest rates and can instead take an active approach to capitalize on opportunities as they appear and mitigate risk during times of heightened uncertainty.

Unlike the equities market, where active managers can lag passive indexes such as the S&P 500, the fixed-income market has far greater inefficiencies, meaning managers with proven expertise, investment processes, risk management, and agility can take advantage of volatility and mispricing to generate higher long-term returns with not much more risk than passive strategies.

Instead of worrying about the nuances of yield curves, credit spreads, the large universe of fixed-income securities and tactical portfolio positioning, leaving the details to experts who live and breathe fixed income is usually the safer bet. That way, one can zoom out and consider their portfolio from a higher vantage point to determine strategic allocations instead of being overwhelmed with small details.

There isn’t a single fixed-income investment approach that outperforms under all market conditions. Without a crystal ball to predict where things will go, it’s often best to hold a basket of different strategies to diversify exposures so that you always have something that’s winning.

In the short term, given current market conditions and the tightness of credit spreads, tilting towards government bonds can provide a decent source of income with low volatility while shoring up liquidity to eventually take advantage of opportunities in corporate credit when credit spreads widen.

In the long term, investing in high-quality corporate fixed-income strategies will likely provide higher risk-adjusted returns.

Some say the only free lunch in investing is diversification. Yet many investors don’t take full advantage of diversification and restrict their strategies to traditional fixed-income investments.

The Canada Pension Plan Investment Board (CPPIB) has demonstrated remarkable success by thinking differently about diversity and asset allocation. In 2000, the CPPIB began to reduce what was largely a government bond portfolio to a much smaller allocation of various income-producing investments today.

Private credit is a different form of investing for income. Recent headlines detailing issues and risks in this sector may prompt investors to shy away. But the private credit market continues to significantly grow, offering investors of all stripes an important form of income from an approximately US$1.4-trillion market.

Similar to traditional banks, private credit firms lend to corporations against collateralized assets or as mortgages secured by real estate, but in a more nimble and responsive manner.

There are liquidity constraints, which should undoubtedly be carefully considered in the context of an overall financial plan. Private credit strategies that manage a diversified portfolio of shorter-term loans and have a long track record of success can be a valuable part of a fixed-income portfolio, offering stable, meaningful, inflation-protected returns.

There are also other unconstrained alternative fixed-income strategies that employ a larger toolkit, including interest rate hedging, defensive shorting and other unconventional strategies across global credit markets.

Some of these strategies can generate strong absolute returns that can serve as a fund and portfolio stabilizer during economic uncertainty due to their active approach focused on capital preservation while generating solid performance under normal market conditions.

Since the difference between making or losing money is finding suitable fixed-income managers, conducting the proper due diligence is critical. But with all the options out there, it’s often impossible for individuals to properly assess each fund on their own, so they turn to wealth advisers.

A wealth adviser with a holistic understanding of your financial circumstances can properly position your fixed-income investments in the context of your overall financial plan to help you achieve your goals.

But investors should also understand an adviser’s investment process and approach to assessing fund managers. Proper due diligence of fixed-income managers should include the evaluation of risk management, portfolio monitoring, historical performance and attribution analysis, as well as both the manager’s and their team’s alignment and skin in the game. Tax considerations are also critical and can vary across funds.

Fixed income is offering meaningful benefits again; now is the time to reintroduce yourself to this asset class.

Craig Machel is a portfolio manager and investment adviser at Richardson Wealth.

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