October 2023
The short maturity fixed income market is the most attractive that it’s been in years, though there are skeptics warning that rates could go higher still. We’ll craft the following paragraphs to argue why it’s an attractive time to take advantage of the current interest rate environment.
One argument against fixed income is that the intermediate fixed income index is at risk for its third consecutive year of losses. To be clear, we are not talking about intermediate fixed income. At Halyard Asset Management, we manage a short maturity fixed income product called Taxable Reserve Cash Management (RCM) that has a maximum maturity of 2 years for fixed rate securities and a targeted average maturity of approximately 13 months for the portfolio. Securities held include a mix of Treasury notes, Treasury bills, and corporate bonds, and a weighted average yield-to-maturity of 5.85%, as of 10/31/23. Since the 2010 inception of Halyard, the RCM has not had a one year in which the performance was negative! In the 157 months it’s been managed, only 26 months had a negative sign next to the result. That’s an 83%-win rate. Of course, past performance cannot guarantee future success. With that in mind let’s tackle some of the other arguments why one should avoid fixed income.
The argument most cited by the financial media is inflation. Inflation eats away the future buying power of an investment at such a rate that at the end of an investment period the consumer is left with less spending power. That’s the textbook definition of a negative real rate of return, but it doesn’t currently apply. Since autumn of 2008 through the end of last year, there have been 3 periods totaling 33 months, in which the real yield (6 month T-Bill rate – inflation) has been positive, according to Bloomberg. The approximate average real yield offered during those 33 months was about 0.5%. The most recent CPI year-over-year rate is 3.7% as of September 2023 as reported by the BLS . Compared to the RCM strategy, the real yield is 2.08%.
The next argument is what if the Federal Reserve isn’t successful in reining in inflation and they need to continue to hike rates further? In such an instance there will be some impact to the real yield, but we think the 208 basis points provides a sufficient buffer. Should inflation again begin to rise, the Federal Reserve would most likely increase rates further. The RCM targets 2% per security position with relatively short maturities, so that as those maturities roll off, the proceeds are available to reinvest, if possible, at the higher rate.
The final argument is truly an absurd one. Sure, 5.85% is an attractive rate, but if one takes money out of the stock market, they’ll give up future appreciation as stock prices rise. Absurd because it assumes that an investor’s portfolio is 100% invested in equities. The traditional 60/40 portfolio of stocks and bonds now offers an attractive return on the bond allocation that will provide downside protection in the event of a drop in equity prices.
Copyright 2023, Halyard Asset Management, LLC. All rights reserved.
