THE CORE CONUNDRUM
PORTFOLIO STRATEGY RESEARCH | FEBRUARY 2013
by Scott Minerd, et al, Guggenheim Partners LLC
As U.S. monetary policy continues to artificially depress yields on government-related securities, traditional core fixed-income strategies have proven less effective in achieving total return objectives. Compounding this issue is the flagship fixed-income benchmark, which has become heavily concentrated in government and agency debt. As benchmark yields languish around 1.9 percent, the chasm between investors’ return targets and current market realities deepens.
Bridging this gap, without assuming undue credit or duration risk, requires a shift away from the traditional view of core fixed-income management in favor of a more diversified, multi-sector approach. An increased tolerance for tracking error provides the flexibility to increase allocations to undervalued yet high-quality credits across sectors. We believe this approach offers a more sustainable way to improve total risk-adjusted returns in today’s low-rate environment.
Report Highlights
• The combined impact of U.S. monetary and fiscal policy has created the core conundrum: How can core fixed-income investors meet their yield objectives while maintaining low tracking error to the Index, which has become approximately 75 percent concentrated in low-yielding government-related debt?
• The benign credit environment is encouraging investors to take investment shortcuts, such as increasing credit and duration risk, to generate yield. History has shown that the market has a tendency to underestimate these risks, particularly during periods of monetary policy accommodation.
• In the current environment, we believe the surest path to underperformance is to remain anchored to the past. Investors must develop a new, sustainable, long-term strategy to generate yield without assuming excessive credit or duration risk.
• Accessing short-duration, investment-grade quality securities with considerable yield pickup relative to government and corporate bonds may be the investment blueprint needed to navigate the current low-rate environment and hedge against interest rate risk.
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