Financial Industry Insights from Advisors Asset Management


AAM Viewpoints – Subverted Bond Expectations

While there has arguably been much controversy over the way the massively popular Game of Thrones series concluded just two Sundays ago, most fans of the epic fantasy drama would have to agree that the final season left no shortage of plot twists or surprises. Some of the most prominent fan theories and character arc projections that developed over eight seasons simply did not come to fruition on screen. Based on the fan petition set up to remake the entire final season, the expectations of millions had been subverted.

In similar fashion, the surprising year-to-date performance of U.S. fixed income markets have also left many investors and strategists dumbfounded and scratching their heads. At the beginning of the year, market forecasts largely pointed toward higher interest rates with strong employment and stable corporate earnings fueling the way. It wasn’t a stretch to expect the 10-year Treasury yield to move back toward their November 2018 level of 3.25% by the end of the 2019 calendar year. Today, that 2.69% yield investors were compensated for holding 10-year government debt back on January 2 is a relative bargain compared to the 20-month low 2.22% level as of May 30. Tax-exempt municipal yields have tightened even more than Treasuries during this span due to the rising demand of many high net worth investors seeking to lighten their tax burdens. U.S.-China trade tensions have muted some Q1 (1st quarter) 2019 economic optimism as market participants continue to flock toward quality assets throughout the second quarter. Expectations for higher yields have yet again been subverted, at least for now.

10-Year Treasury and 10-Year AAA Municipal Yields Year-to-Date


Source: Bloomberg | Past performance is not indicative of future results.

Though the staunchest Game of Thrones fans may beg to differ, there are – of course – “real-life” consequences when market expectations are subverted. Markets quickly adapt and move on but investment goals and income targets, on the other hand, generally remain the same and still need to be met. It goes without saying that achieving those income targets have become immensely more difficult to attain in this low-rate environment. Below are a few guidelines that should help fixed income investors better manage market uncertainty and make sound decisions:

Identify and Analyze

In other words, know what you own and understand why you own it. This applies to both fixed income asset classes as well as individual credit holdings. When investors are pressed for yield, credit quality is often one of the first components of a portfolio that gets compromised. Between 2016 (when Treasuries hit their all-time lows) and today, it would not be surprising if a few suspect credits were added to an average bond portfolio during that span. Not only should fixed income investors familiarize themselves with the potential balance sheet issues of a corporation or the pension liabilities of a municipality, knowing the current spreads of similarly rated corporate or municipal bonds would also help investors determine how much they are getting compensated for the risk of holding the security.

Diversify Exposure

During bouts of market volatility, astute equity managers are vigilant about portfolio diversification, making sure not to be overexposed to any single security, industry, or country. In the same vein, fixed income allocations should be no exception to the concept. On a daily basis, the Treasury yield curve is continuously manipulated by different forces: Federal Reserve influence, economic growth projections, inflation expectations, etc. An “all-weather” strategy based on diversifying across different parts of the yield curve has the potential to help insulate a portfolio from an unexpected market event. On the municipal front, the long-term merits of a regionally diverse municipal bond portfolio have the potential to far outweigh the triple-tax-exempt perks of an in-state portfolio. Not only do investors typically need to pay substantially higher premiums to own paper issued by their own state of residence (which is very much the case today), they potentially could be exposing themselves to unsuspecting danger. No state or municipality is immune from prolonged fiscal, economic, or political issues. 

Maintain Current Strategy

In our opinion, if a fixed income portfolio is fully invested and a long-term strategy is already in place, the best course of action amid market-changing factors may simply be the most obvious one: stand pat and collect the coupon. Income is the main driver of fixed income total returns so the higher the coupon on a bond, the more predictable its return will be by year-end. In our view, while a flexible stance along with smaller tactical shifts may be warranted along the way, the main objective is to remain disciplined and avoid compromising trades.

CRN: 2019-0603-7462R  

This commentary is for informational purposes only. All investments are subject to risk and past performance is no guarantee of future results. Please see the Disclosures webpage for additional risk information at commentary-disclosures. For additional commentary or financial resources, please visit


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