Fixed income markets were choppy to start the year, with price movements heavily influenced by changing market expectations for interest rate cuts by the Federal Reserve (Fed). Recent economic data releases offered ammo for both the bulls and the bears, as strong consumer spending and moderating inflation were balanced by higher jobless claims and signs of a slowdown in the labor market. Meanwhile, markets continue to price in a soft-landing certainty, with historically tight spreads across much of the corporate bond market. In his mid-year outlook, Mike Sanders, Head of Fixed Income at Madison Investments, suggests that investors may be overlooking risks. Watch as he shares where we are finding opportunities and value in the fixed income market.
Explore our Fixed Income Funds & ETFs
Transcript
Mike Sanders
I believe most investors today are focused on all-in yields, which are quite attractive, probably ranking 65th to 70th percentile in terms of aggregate yield. However, the spreads are narrow. From an investment standpoint, I think corporate spreads are not really reflecting the potential for a hard landing, even though a hard landing is not our base case. It’s important to be aware of the risks you’re taking and how much you’re being compensated for those risks. Although all yields are appealing, you don’t need to compromise on quality too much to earn good all-in yields for high-quality investments. This is what I believe investors should focus on, rather than trying to squeeze out the last bit of yield in the current environment.
Regarding financials, it’s an area we favor. We believe that capital ratios are robust, and many of the liquidity issues from last year have been resolved. Weaker players with poor funding mixes have been eliminated. Because of strong capital levels, we anticipate that banks should perform well, even if the economy slows down toward the end of this year or into the next. With regards to utility bonds, one area that’s becoming increasingly interesting is the natural disaster risk – such as fires, floods, and storms – which can impact these securities. Depending on the specific bonds you own, this could be a bigger concern than investors had considered 15 to 20 years ago. It’s essential for investors to be aware of the type of utility bond they hold and its geographic exposures. As for industrials, there’s a division between very high-quality industrial bonds that are essentially bulletproof credits but trade at very tight spreads, and lower-quality industrial bonds. The upgrade/downgrade ratio has seen more upgrades than downgrades, which has likely peaked. If the economy remains steady, this is fine. However, if the economy slows down a bit, some of these companies may have issues maintaining investment-grade ratings given their current debt structures.
Given the economic outlook and where spreads are, we believe financials are still appealing, trading at slightly wider levels than some parts of the industrial market. We like bank bonds and the securitized space. Asset-backed securities are positioned attractively on the yield curve, especially given the inverted yield curve, and we believe they will perform well through the latter half of 2024. We also favor high coupon mortgages, particularly 4.5% and 5%, as we anticipate they should perform well if the yield curve steepens.
Areas where investors should exercise caution include lower quality credit and possibly private credit, particularly in an environment with less liquidity due to a potential slowdown. It’s important to recognize that there are always risks involved in investing and to be able to accept the risks you’re taking. Rather than solely focusing on yield, it’s crucial to consider the risks you’re taking to achieve that yield. There are no bad bonds, just bad bond prices. Therefore, being aware of the potential downsides and what you’re gaining to take on that risk is something that people need to be cognizant of.
Disclosures
Before investing, please fully consider the investment objectives, risks, charges and expenses of the fund. This and other important information is contained in the current prospectus, which you should carefully read before investing or sending money. For more complete information about Madison Funds® obtain a prospectus from your financial adviser, by calling 800.877.6089 or by visiting www.madisonfunds.com/ETFProspectusReports to view or download a copy.
“Madison” and/or “Madison Investments” is the unifying tradename of Madison Investment Holdings, Inc., Madison Asset Management, LLC (“MAM”), and Madison Investment Advisors, LLC (“MIA”). MAM and MIA are registered as investment advisers with the U.S. Securities and Exchange Commission. Madison Funds are distributed by MFD Distributor, LLC. MFD Distributor, LLC is registered with the U.S. Securities and Exchange Commission as a broker-dealer and is a member firm of the Financial Industry Regulatory Authority. The home office for each firm listed above is 550 Science Drive, Madison, WI 53711. Madison’s toll-free number is 800-767-0300.
Madison Asset Management, LLC does not provide investment advice directly to shareholders of the Madison Funds.
An investment in the fund is subject to risk and there can be no assurance that the fund will achieve its investment objective. The risks associated with an investment in the fund can increase during times of significant market volatility. The principal risks of investing in the fund include: interest rate risk, call risk, risk of default, liquidity risk, mortgage-backed security risk, credit risk and repayment/extension risk, non- investment grade security risk and foreign security and emerging market risk. As interest rates rise, the prices of bonds fall. Long-term bonds are more exposed to interest-rate risk than short-term bonds. Unlike bonds, bond funds have ongoing fees and expenses. More detailed information regarding these risks can be found in the fund’s prospectus.
High yield bonds are considered lower-quality instruments known as “junk bonds”. Such bonds entail greater risks than those found in higher-rated securities.
In addition to the ongoing market risk applicable to portfolio securities, bonds are subject to interest rate risk, credit risk and inflation risk. When interest rates rise, bond prices fall; generally, the longer a bond’s maturity, the more sensitive it is to this risk. Credit risk is the possibility that the issuer of a security will be unable to make interest payments and repay the principal on its debt. Bonds may also be subject to call risk, which allows the issuer to retain the right to redeem the debt, fully or partially, before the scheduled maturity date. Proceeds from sales prior to maturity may be more or less than originally invested due to changes in market conditions or changes in the credit quality of the issuer.
In a low-interest environment, there may be less opportunity for price appreciation.
Madison Funds are distributed by MFD Distributor, LLC, member of FINRA. Portfolio data is as of the date of this piece unless otherwise noted and holdings are subject to change.
Any performance data shown represents past performance. Past performance is no guarantee of future results.
Non-deposit investment products are not federally insured, involve investment risk, may lose value and are not obligations of, or guaranteed by, any financial institution. Investment returns and principal value will fluctuate.
This report is for informational purposes only and is not intended as an offer or solicitation with respect to the purchase or sale of any security.
Bond Spread is the difference between yields on differing debt instruments of varying maturities, credit ratings, and risk, calculated by deducting the yield of one instrument from another.