Finding the fixed income balance critical for income in portfolios

Investors got a preview of how fixed income markets might respond to a return of inflation earlier this year, when in the March quarter, US Treasury yields rose by around 75 basis points and asset prices fell sharply.

Portfolio Manager Brian Kloss at Brandywine Global, a specialist investment manager of Franklin Templeton, says the lesson income investors must learn from the March quarter bond sell-off is that global corporate credit is a good place to strike the right balance between identifying the opportunities from the post-COVID global economic recovery and insulating their portfolios from a pick-up in inflation.

Kloss is part of the team that looks after the Brandywine Global Income Optimiser Fund, which returned 6.19% (net of fees) for the 12 months to the end of July and has produced an average return of 8.34% a year over the past three years.

The Fund has the dual aims of maximising income while preserving capital. It pursues this objective by investing actively across the full range of global fixed income markets.

Kloss says: “In the near term, investment grade corporate bond spreads could see another 20 basis points of tightening and below-investment grade corporate bond spreads could tighten by 50 to 100 basis points.

“We are constructive on corporate credit, especially at the shorter end of the curve, but opportunities will be selective and uneven. Active management will be the key.”

Kloss says that if inflation returns for real, and assuming it is the result of stronger economic growth, longer-duration assets will be repriced across the quality spectrum.

“In this scenario we would expect more equity-like assets, lower-quality securities with shorter maturities and pricing power, to outperform other fixed income segments,” he says.

In terms of industry sectors, Kloss favours commodities and basic materials, which are poised to benefit from the post-pandemic economic reopening.

“We are also focused on those entities that have pricing power as a potential hedge against rising prices,” he says.

The Brandywine Global Income Optimiser Fund’s investable universe includes a broad mix of global securities, including but not limited to: sovereign debt, emerging markets debt, global high yield and investment grade credit, structured credit, convertible securities, preferred or common stock, and currencies.

This flexibility allows Income Optimiser to source income from areas where it is attractive and available while avoiding where it is not. As different asset class, sectors, industries, and parts of the capital structure come in and out of favour, Income Optimiser seeks income from the market sub-sectors with the most favourable income profiles.

Kloss says: “Current asset price profiles imply expectations for strong and long-lasting economic growth, a transitory spike in inflation, and a smooth tapering of the Federal Reserve’s balance sheet at some point in the future.

“There are no guarantees surrounding this sanguine view and there is no historical recovery road map for navigating a world full of pandemic-related distortions, along with substantial stimulus measures set to be dialled back at various stages. It is too soon to answer the inflation question.”