Over the last seven years - as central banks have rolled out more quantitative easing programs and moved benchmark interest rates below, or close to, zero - global fixed income markets have dramatically changed. Here’s a quick look at four charts showing just a few of the interrelated ways the fixed income landscape is different today.
We now live in a persistently low rate environment, where decent yields are scarce. In 2005, virtually every asset in the Barclays Global Aggregate Index and Global High Yield Index was yielding at least 3 percent (with the exception of Japanese Government Bonds), and there were a variety of duration options. A decade later, only relatively small pools of assets (such as high yield and emerging market sectors) are offering 3 percent yield or greater, according to our analysis , and the higher yields require extending duration. See the charts below, where the size of the bubbles represents the size of each respective market.
Developed market sovereign rate volatility has spiked higher. Rate volatility levels are running higher, and in some cases, developed market rate volatility now resembles that of emerging markets, as evident in the chart below. Going forward, Fed policy remains a major source of potential rate volatility: We could see volatility spike if markets begin to perceive that the Fed has fallen behind the curve and allowed inflation to run too hot. In addition, policy missteps from the European Central Bank (ECB) and Bank of Japan (BoJ) also now have the potential to drive interest rate volatility, as we have seen over the last year.
Against this changed market landscape, the risks for traditional fixed income investors have increased, and the need for diversification and flexibility in fixed income has become greater than ever. In other words, navigating today’s bond environment requires having a flexible approach in a bond toolkit.
Flexible fixed income funds allow fund managers to look for opportunities across a wide set of fixed income asset classes without having to stay tied to a specific broad bond market benchmark, and can potentially provide investors with an attractive hedge to traditional fixed income. Through accessing a wider and more diverse set of opportunities - including global bonds, high yield, and emerging markets - less constrained funds can potentially increase returns, while potentially reducing volatility and sensitivity to interest rates.
A flexible fixed income fund does come with risk (such as credit risk), but it doesn’t seek to take on more risk than a traditional bond portfolio. Rather, the objective is to create a diverse allocation that strikes a balance between return and principal protection, potentially creating a fixed income return stream that is less dependent upon and beholden to the movement in interest rates. For more on flexible fixed income funds, check out my explainer on what unconstrained investing is and isn’t.
This post originally appeared on the BlackRock Blog.