Interest rates across the curve are at historic lows and have been steadily declining for much of the last two decades. Pundits have searched for reasons behind this long-term trend, citing income inequality, technological advancement and demographics as possible culprits. The coronavirus pandemic further exacerbated the falling interest rate trend.
To help combat the strain on economies, central banks around the world have been taking extraordinary measures, providing never before seen levels of support through monetary policy. Despite initial signs of healing in the global economy, policy makers seem committed to keeping short-term rates low for at least a few years. This commitment to low policy rates, however, only serves to further affirm the current state of yields. Once considered a temporary measure, low, and even negative, rates, seem to be here to stay.
Even with the back up in long-term rates in 2021, the current level of long-term interest rates is still lower than the world had ever seen prior to the coronavirus pandemic. The rise in long-term rates that has been taking place since last August is just a re-tracing of the decline in rates experienced during the pandemic.
With this as backdrop, investors are left with a challenging question: should I continue to own high quality fixed income in my portfolio? We argue that, despite the current environment, interest rate exposure still plays a valuable role in portfolios. More specifically, we believe that even in a rising rate environment investors should consider maintaining an allocation to high quality bonds. The higher Sharpe Ratio nature of the asset class, paired with its diversification benefits, allows fixed income to add value in portfolios even when yields are low and rising.