Craig Bishop, lead strategist of RBC Wealth Management’s U.S. Fixed Income Strategies Group, thinks it’s time for advisors and their clients to curb their enthusiasm for high yield.
RBC has about 2,000 advisors, and Bishop‘s team helps set RBC Wealth Management’s views on rates and credit, informing the firm’s guidance on asset allocation and portfolio construction.
Bishop recently visited ThinkAdvisor’s New York office to discuss his thoughts on the interest rate environment and why investors should stop chasing yield.
“Ever since the end of the great recession back in ’08 and ’09, and when the economy began to turn up, it’s been the natural inclination of analysts and/or professional investors and individual investors to think that interest rates were going to soon begin to rise again,” Bishop told ThinkAdvisor. “And they haven’t.”
And Bishop doesn’t think they will anytime soon. His view has been for some time that “we’re in a lower-for-longer interest rate environment,” and he said he doesn’t see anything on the horizon that’s going to change that.
“You look at a world of slow global growth, low inflation, central banks — outside of the Fed — still remaining relatively accommodative, and I think to us that spells this continuation of this lower-for-longer interest rate environment,” he explained.
This low-rate environment does pose challenges for investors that want to earn more on their money. Investors have often done that by chasing yield or taking on additional credit risk or duration risk, which Bishop thinks has had an effect on the market.
“This demand for higher yield has caused spread relationships between high-yield and investment-grade credits to narrow significantly,” he said.
Bishop thinks we’ve reached the point where investors should start paring down their exposures to lower-rated credit.
“That’s something we’ve been talking to our advisors and clients about for the past few months,” Bishop said. “It’s time to curb your enthusiasm for high yield.”
What Bishop means is that investors should consider buying a BBB-rated investment-grade bond instead of buying a BB-rated high yield bond. And then, as spreads continue to tighten, from BBB-rated to A-rated or AA-rated.
“It’s just moving up the credit quality rating to reduce risk,” he explained.
Bishop said developing a more cautious approach is a good way to protect portfolios for future events.
“Our belief is that there’s never a perfect hedge, but in times like these when you’re starting to see some warning signs on the horizon, there are things you can do to help mitigate the impact on your portfolios going forward,” he said.
According to Bishop, one warning sign that he sees in the market is “so much demand for issues that offer less protection for investors.” He said that the demand for yield is so high that issues could come to market with yields that historically wouldn’t have been considered attractive but now are. These issues can come to market with less protection for investors than they used to have and there’s still demand for it, Bishop added.
“To us, these are times when you want to make some of those changes and begin to downsize and de-risk portfolios a little bit,” he said. “Be the first person out the door, rather than wait for when an event actually happens and then you’re part of the crowd trying to get out of a small door.”
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