Your Investment Playbook: Buying Back Into Bonds

Kennedy, portfolio manager on Loomis Sayles’ Full Discretion Team, CFA, head of fixed income client portfolio management, global fixed income at Northern Trust, shared their outlooks in the Fixed Income Symposium hosted on the VettaFi platform.

The onset of Fed rate cuts in September brought a significant influx of flows back into bonds. In an environment of rising rates and elevated risk, Treasury bills and money markets proved lucrative for investors. However, the impending U.S. presidential election remains a temporary roadblock for many, with the ensuing potential for elevated volatility in the short term.

“I do think on a secular basis, we’re looking at a more challenging inflation environment than what we’ve dealt with over the past 20 years,” Kennedy cautioned. In such an environment, rates would likely remain elevated for a longer period of time. In the short term, however, Kennedy believes recent economic data proves to support at least one more rate cut before year’s end.

One of the top questions that advisors and investors weighed in the last year is about timing and when it’s the right time to move out of money market funds and T-bills. “My answer was you should have already done some of that,” Kennedy said. Those investors who began to move into longer-duration exposures benefited from yields of nearly 5% on 10-year Treasury notes.

As rates decline, the yield-rich front end of the curve will continue to retreat, making longer-duration bonds more attractive. “Eventually, on the back-end [of the yield curve], you would expect rates to start to come down,” explained Walny. “Right now, they’re not — they’re going up, at least this month — so you get another great entry point as you extend that.”

When considering their bond allocations, investors should weigh their liquidity needs, desired yield targets, and tax sensitivities when selecting exposures. Also, in a declining inflation and rate environment, fixed income will likely return to its more traditional low-correlation hedge to stocks within portfolios, according to Walny.

For those investors looking to make incremental moves out of money market funds, ultra-short duration may prove a solution. Northern Trust offers the FlexShares Ultra-Short Income Fund (RAVI C+) and the Northern Ultra-Short Fixed Income Fund (NUSFX).

While the front of the curve offers the most liquidity, Kennedy quickly pointed out that the U.S. bond market is the most liquid globally for all durations. “With the additional duration, there’s volatility, but plenty of liquidity in the Treasury market,” Kennedy noted. “It’s one of the reasons why, as the U.S. continues to build up its deficit, you don’t see buyers pushing away from the Treasury market because there’s no alternative.”

Investors wanting to move out in duration should consider the Loomis Sayles Investment Grade Bond Fund (LSIIX). The mutual fund falls into the intermediate core-plus bond Morningstar category with an average duration of 6.01 years as of 06/30/24.

Looking ahead, Natixis remains optimistic about the Fed navigating the rate cycle without propelling the economy into a future recession. “We do think that soft-landing scenario that so many talked about is coming to fruition, but one thing I think we should push back on is whether or not the inflation rate actually hits the two percent target.”

In an environment where equity profitability remains stable, Kennedy sees an opportunity in corporate bonds. This includes investment-grade and high yield bonds, though security selection remains critical. Natixis considers high-yield bonds from companies ascending to investment grade a vital opportunity in the current environment. Kennedy also cautioned investors to look beyond spreads and consider losses when considering credit investments.

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