• Fixed Income serves two purposes in a portfolio:
1. To diversify a portfolio from equity exposure; and
2. To provide a source of return
• The prospects for Part 2 of that equation have diminished
substantially given yields in government and investment grade
bonds have declined so dramatically over the past 30 years.
• While the diversification function is still alive and well, many
investors have been not just finding returns in the traditional
way: lowering the credit profile or increasing duration, but also
steadily reducing their allocation to traditional fixed income in
an attempt to find more returns.
• As a result, we believe many portfolios are exposed to risk that
isn’t being properly recognized.
• We examine some of the private market alternatives being used
to complement or even replace fixed income in portfolio
• Hedge Funds
Private Debt funds
Mortgage Investment Corporations
In our examination, we discuss the benefits and risks of each asset
class as they relate to common portfolio construction.
Once upon a time, the classic portfolio mix was created by taking
100 less your age to determine the equity allocation in your portfo-
lio. The rest went to fixed income. Of course, that rule of thumb
was designed in an era where fixed income allocations were both
plain vanilla (more on that later) and offered some fixed real returns.
The 60/40 portfolio, referring to 60% equity and 40% fixed income
became the standard benchmark, where the fixed income was gener-
ally made up of government and investment grade corporate bonds.
Starting in 1981, but particularly since 2008 when central banks
around the world began slashing rates, yields, but not so much
returns, have diminished on our fixed income portfolios. At first,
we didn’t mind. Starting yields had been healthy, and with inflation
and rates dropping, the capital gains in our bond allocations gave
great total returns (as yields drop, the price of bonds rise).
Eventually, however, bonds mature. If a 5 year bond is bought with
a yield of 6% and held to maturity, the average return over the 5
years WILL BE 6%, even if yields drop throughout. Returns
measured year by year will start out great, but decline quickly such
that they average 6%. For fixed income investors, dropping yield
feel good along the way, but eventually bonds mature.
By James Price
RICHARDSON GMP - What of the 40?
When the bonds mature, we must re-invest at prevailing market
yields. Since the purchase yield so closely resembles the ultimate
return, this spells trouble. The days of declining yields appear to
What OF the 40?
An analysis of Fixed Income in portfolio building and the private
market alternatives that are often substituted