Fixed income: Yield and diversification with bonds

New opportunities for institutional investors with fixed income

What a difference a year makes. Developments over the past 12 months have ensured that fixed income once again offers attractive return prospects. In which areas institutional clients, who are underweight in fixed-rate bonds, can build up their portfolio.

A turning point for fixed-rate bonds

Stefan Meili, Head of Pension Funds & Corporate Investors for Region Zurich, Credit Suisse (Switzerland) Ltd., begins the institutional investor presentation "Change of regime for fixed-income investments" with a retrospective. "Let's look back to last year: Inflation was 1.5%, the SARON was -0.71%, and a 10-year federal bond was 0%. The SARON is now at 0.94%, a 10-year federal bond yields 1.1%, and inflation has risen to 2.8%."

That was not without consequences. For a long time, bonds were rather unpopular, Stefan Meili continued. "This is no longer the case. Fixed income is once again a very good investment category for pension funds, also for asset liability reasons."

Interest-rate moves lead to higher returns on fixed income

Agnes Rivas, PF&CI Strategy Consultant at Credit Suisse (Switzerland) Ltd., agreed. "A fundamental change took place last year. We have left the era of negative interest rates behind." In the short term, this means falling funding ratios for many pension funds. However, they are likely to recover over a longer period, as the change also leads to a lower valuation of obligations.

At the same time, the key interest rate hikes ensure that fixed-income yields have risen across the entire maturity spectrum. This development is likely to continue. "We are assuming that extremely low interest rates are gone for good," said Agnes Rivas. In their forecasts, Credit Suisse experts expect long-term returns in the low single-digit percentage range.

Bonds are becoming more relevant in the portfolio

The positive return expectations mean that bonds can once again play a more important role in the institutional portfolio. However, returns are not the only thing in favor of fixed income. An analysis of the monthly performance of equities and bonds since 1988 shows that bonds have also proved to be a hedge against bad months for equities.

"In 62.5% of the months with negative equity performance, bonds were able to compensate for this," explained Agnes Rivas. "The worse equities performed, the better the hedge worked." Bonds performed positively in more than 67% of the months in which equities lost more than 5% in value.

Hedging costs weigh on returns on fixed-income investments in foreign currencies

Matthias Rentsch, Senior Specialist for Fixed Income at Credit Suisse Asset Management (Switzerland) Ltd., also emphasized the positive overall outlook for bonds. In the case of global corporate bonds, yields to maturity rose sharply in 2022, while duration declined. As a result, "we are currently at a very interesting level with the average return per year duration," says Matthias Rentsch.

However, hedging costs for foreign currency bonds remain an important topic. "These are particularly significant in the USD area," says the fixed-income specialist. This is putting pressure on returns. He therefore advises institutional clients who want to increase their share of bonds in their portfolio to consider bonds in Swiss francs as a first step.

Fixed-income investments with low risk are attractive

The comparison of the returns of various fixed-income investments over the past ten years provides specific indications of which bonds are currently available for increasing the fixed-income component in the portfolio. "The riskiest investments offer too little return in the current environment in exchange for the high risks," said Matthias Rentsch. Investment-grade corporate bonds and corporate short-duration bonds, in contrast, offer attractive return opportunities, he said.