Bonds Are Back: Why Fixed Income is a Prime Opportunity for Investors

In a recent presentation, Benoit Anne, a senior investment professional from MFS Investment Management, emphasized that we are entering a golden era for fixed income investments. Benoit, with over 30 years of experience in the financial markets, shared insightful perspectives on why bonds and other fixed income securities are once again a key pillar in investor portfolios.

Here are the key takeaways from his presentation, explaining why this is an opportune moment to allocate capital toward fixed income.

Rate Cuts and Higher Yields: A Winning Combination for Bonds

Benoit began by highlighting two driving factors behind fixed income’s resurgence: rate cuts and yield carry.

The Bank of Canada, like other central banks, has begun cutting interest rates to stimulate the economy. Benoit predicts another 50-basis-point (0.50%) cut soon, which has a direct positive effect on bond prices. When interest rates fall, bond prices rise, enhancing the value of fixed income portfolios.

Moreover, current yields (the income generated by bonds) are highly attractive. For example, the yield on U.S. Investment Grade (IG) corporate bonds is hovering around 5.5%, while Canadian IG bonds offer similar returns. In Canada, Benoit suggests we could see high single-digit returns over the next year for bonds, which is impressive for such a low-risk asset class. These returns, coupled with decreasing rates, make this a favourable environment for bond investors.

A “Goldilocks” Economy is Perfect for Fixed Income

Benoit described today’s economic environment as a "Goldilocks" scenario—not too hot, not too cold, but just right. Inflation is moderating, central banks are cutting rates, and the risk of a recession remains low. All of these conditions bode well for fixed income returns.

For instance, in this environment, Canadian and global bonds are expected to generate annualized returns of around 5-7% over the next five years. Historically, fixed income in such a regime has produced double-digit total returns. In contrast, periods of higher inflation and aggressive interest rate hikes, such as the last two years, have negatively impacted bond returns, which is why the shift in monetary policy is so crucial

Diversification and Stability in a Volatile Market

Another key point Benoit made was that bonds, especially government and investment-grade corporate bonds, are returning to their traditional role as a stabilizer in portfolios. This is particularly important in a high-risk equity market where valuations are stretched.

Equity markets, both in Canada and globally, are showing signs of froth, with rising prices potentially masking underlying risks. Meanwhile, bonds offer lower volatility and stable returns, making them essential for balancing risk. Benoit used the example of a typical Canadian Investment Grade bond portfolio yielding around 4.5%. With the expected rate cuts factored in, the return could rise to around 6%, providing strong returns with significantly less risk compared to equities.

Active Management Adds Value

Benoit also stressed the importance of active management in fixed income portfolios. Active bond managers, who carefully select securities, adjust durations, and manage risks, can provide excess returns (alpha) beyond what the benchmark offers. Historically, these managers have generated 75 basis points of excess return annually over the long term (83 basis points for global bonds - see below).

Although this might not seem like a significant number, compounded over several years, it has a profound effect. Benoit illustrated this by comparing the performance of an index yielding 3% per year with an actively managed bond portfolio generating an additional 0.75% annually. Over 20 years, this could result in over $28,000 of dollars of additional returns on a $100,000 initial investment, simply due to the power of compounding.

Timing is Key: The Case for Long-Duration Bonds

A significant part of Benoit’s message was about duration, which refers to the sensitivity of bond prices to changes in interest rates. With interest rates likely to decrease in the near term, extending the duration of your bond holdings could enhance returns.

Long-duration bonds, such as U.S. Treasuries, are particularly well-positioned. For example, a portfolio of long-duration U.S. government bonds could generate annualized returns of around 5% over the next five years, a remarkable figure for such a low-risk investment.

This is especially relevant in the current environment, where both the Bank of Canada and the Federal Reserve are expected to continue cutting rates, which would push bond prices higher.

Bonds as a Hedge Against Market Volatility

Despite the strong performance of equity markets, Benoit warned that the risks associated with stocks remain elevated. Geopolitical uncertainties, potential election-related market disruptions in the U.S., and trade tensions could all contribute to volatility in the near term. Bonds, on the other hand, provide a safe haven in turbulent markets.

Interestingly, in today’s market environment, bonds are also rallying alongside equities, a phenomenon not usually seen. This unique high-correlation environment means that fixed income can still play a vital role in portfolios, not just as a defensive tool, but as a generator of stable income.

Move Away from Cash

Many investors are still holding large amounts of cash, which Benoit cautioned against. Cash yields have peaked, and as central banks continue to cut rates, cash will no longer provide meaningful returns.

Benoit stressed that cash is no longer king. Investors holding cash today face the risk of losing purchasing power, especially when they could instead be earning solid returns from bonds. With central banks poised to cut rates further, the opportunity cost of holding cash is becoming increasingly clear.

Conclusion: Fixed Income is Back

To conclude, Benoit made it clear that fixed income is back and should play a central role in any well-diversified portfolio. With central banks cutting rates, inflation moderating, and the risk of recession low, bonds are once again fulfilling their role as stable, reliable investments that generate solid returns with lower risk.

Whether you're an individual investor looking to stabilize your portfolio or a business professional managing corporate funds, fixed income offers a compelling opportunity in the current market. As Benoit said, this "Goldilocks" environment makes now the ideal time to reinvest in bonds and take advantage of their newfound strength.

Source: in person presentation from Benoit Anne, and this article he wrote that summarizes most of his points: https://www.mfs.com/en-ca/institutions-and-consultants/insights/fixed-income/big-mac-on-fixed-income-allocation.html