By Russ Kamp, Managing Director, Ryan ALM, Inc.
I don’t know Bob Michele, JP Morgan’s CIO for fixed income, but I absolutely agree with his sentiment when he said on Bloomberg Television’s “Wall Street Week” that “bonds are back”! He said, “Every wealth-management platform in JPMorgan, every institutional client — they’re coming to us, they’re putting money in bonds.” Clearly one of the reasons for his and his clients’ excitement has to do with the dramatic increase in yields this year. The BB Aggregate Index is currently yielding 4.75% up from roughly 1.75% at the start of 2022. What he failed to mention was the fact that return-seeking fixed-income strategies benchmarked to the Agg. have produced a nearly -13% year-to-date return.
We, at Ryan ALM, love bonds, too, but we don’t believe that they are performance drivers. Importantly, they are income producers. Bonds are the only asset class with a known terminal value and semi-annual cash flows. Given the uncertainty in the markets due to Fed policy, we believe that those bond cash flows should be used to secure a defined benefit plan’s promised benefits (and expenses). We don’t know where interest rates will be in the near future. But we do know that pension plans have a monthly obligation to make benefit payments. Establish a liquidity portfolio through a cash flow matching product using bonds that will make sure that the cash necessary to fund those promises is there.
We appreciate Mr. Michele’s enthusiasm for bonds but understand that a rising rate environment will negatively impact the price of bonds. As a reminder, a bond with a 10-year duration will suffer a -10% price loss for every 100 bps move up in rates. We’ve had several Fed Governors suggest that Fed Funds rates need to rise significantly above their current level to achieve real rates with an inflation premium. Return-seeking fixed-income strategies will get hurt. Cash flow matching eliminates interest rate risk, as future values are not interest rate sensitive while buying time for the plan’s alpha assets to grow unencumbered. This is the epitome of a “sleep well at night” strategy. Go bonds!