The New Era of Bond Investing: Five Plays to Build a Fixed Income Portfolio

With inflation running as high as in the 1980s, the Federal Reserve has gone on a period of tightening at a pace not seen since, well, the 1980s. Going from zero to now 5.25% has had a dramatic effect on bond pricing. The benchmark Barclays Global Aggregate Bond Index managed to return a whopping negative 17.7% last year. Other segments of the bond market did far worse.

With that pricing drop and yield rise, the fixed income sector has somewhat reset itself. What worked well over the last decade has the potential to not work anymore. To that end, J.P. Morgan has outlined five plays for the new era of bond investing. All in all, the bank sees a supportive environment for bonds as both the economy and inflation cools. Current yields and potential in various credit markets can drive returns, if investors bet on the right segments of the market.

Here are the top five plays for the new era.

Investors continued to hoard cash at a rapid rate. However, that may be a problem with persistent inflation. Despite T-bills and money market funds paying over 4.5%, that is still below rates of inflation. Investors will do better moving out just slightly on the scale and into short duration bonds or those with maturities of one to three years. Yields here are higher than cash, and yet the bonds are very liquid and provide safety/stability.

With that, JPM recommends segmenting your cash and placing more of your holdings in this area. The JPM-sponsored and actively managed JPMorgan Ultra-Short Income ETF (JPST) has quickly become a behemoth and top performer in this sector. The iShares Short Maturity Bond ETF (NEAR) is another fine choice.

With cash and short-term bonds garnering much of investors’ attention, longer-term bonds are a huge value, particularly when accounting for their potential to see capital appreciation once the Fed stops raising rates and even cuts them. According to JPM, where long-term bonds’ yields are today is a sweet spot for portfolios. Investors are getting plenty of current income to help drive returns today and they offer plenty of appreciation tomorrow when the Fed cuts. This sweet spot is ripe for exploitation by investors willing to go long in their portfolios.

The Vanguard Long-Term Investment-Grade’s (VWESX) management focuses their attention on top quality bonds in the corporate and treasury sectors, using fundamental analysis to generate stability. Another choice? Zero-coupon bonds. These ultra-long-term bonds will surge once the Fed cuts rates and the PIMCO 25+ Year Zero Coupon ETF (ZROZ) is a great way to play it.

With recessionary forces growing and worries about economic conditions rising, JPM surmises that high yield bond defaults will rise. The problem is that current spreads don’t adequately compensate investors for the additional risk. According to JPM, credit spreads for high yield vs. Treasuries are too close together than historic norms. However, spreads for investment-grade corporate bonds versus Treasuries are above historic norms. This makes them a better value.

Investors have plenty of choice in the sector, in both active and passive funds. For example, the SPDR Portfolio Corporate Bond ETF (SPBO) is a great low-cost passive choice, while the active Fidelity Corporate Bond (FCBFX) also remains a solid choice.

In addition to these broader themes, JPM believes that staying closer to home is a good idea. U.S. bonds should win out over European and emerging market ones. Thanks to very high rates of inflation, JPM doesn’t believe that the ECB will cut rates any time before the end of 2024. This limits the capital appreciation and total aspect of fixed income investments in the region.

Additionally, investors with access to private credit funds and solutions should be able to see good returns. These funds with lock-up periods, floating rate loans, and other debt securities will provide plenty of cushion for portfolios. While generally reserved for HNW investors, the number of private credit funds has expanded to include the retail investing set. Investors with access may want to consider these funds.

All in all, the fixed income environment was reset with the Fed’s path of tightening. As such, investors need to rethink their playbooks. The five themes J.P. Morgan lays out could be seen as a roadmap for success this year and beyond.

Here is a list of some of the top-performing funds to get exposure to JPM’s strategy discussed above.

All in all, the fixed income environment was reset with the Fed’s path of tightening. As such, investors need to rethink their playbooks. The five themes J.P. Morgan lays out could be seen as a roadmap for success this year and beyond.