We recently updated, expanded, and put a new face on a whitepaper we had written last year called, “Why Tactical Fixed Income is Different.” You can access the new paper here.
In the original version, we looked at some of the reasons why a simple tactical strategy that commonly works in equities (e.g. go to cash) does not always work well in fixed income. The main takeaway of the original paper was that the income payments (dividends) from fixed income ETFs play a big role in your total return and naively using momentum to manage risk often leaves you worse off.
However, in our Multi-Asset Income strategy, we do go to cash to manage risk, and many of the assets in the strategy’s investment universe are fixed income ETFs (bank loans, high yield, corporates, long-term U.S. Treasuries, international Treasuries, EM bonds, etc.). This is where prudent portfolio construction comes in.
In the revised version of the paper, we investigate this by looking at what happens when you are more thoughtful in how you construct the tactical fixed income strategy. When the investment universe is diversified, instead of going to cash, you are generally reallocating to other assets and only going to cash in extreme market environments. For instance, if the momentum signal on high yield turns off, you might end up investing in REITs. While you forfeit the income you would have earned in high yield, you earn the income in REITs and likely protect your capital in the process.
When designing any tactical fixed income strategy (or any strategy for that matter), keeping the objectives in mind is crucial. All strategies will go through market environments that are more favorable than others, but having a strategy that keeps a keen eye on its objectives regardless of the market environment makes building total portfolio solutions for clients much more straightforward.