The time has come to break investment tradition

The time has come to break investment tradition
Photo by Karolina Grabowska from Pexels

The 60/40 portfolio split between equities and bonds has been a well-known and trusted strategy for decades, created to provide investors with a balanced, stress-free portfolio that offers the security of bonds alongside the potential for growth from riskier equities.

However, times have changed, particularly since the pandemic and lockdowns that started in March 2020. And in a period of consistently low bond yields, the safety and comfort that investing in bonds once provided can no longer be relied on.

So, it’s vital that investors re-examine and re-imagine how that typical 40% fixed income allocation is formed. For those who are willing to break from tradition and look beyond the typical make-up of government and investment-grade corporate bonds, we believe there are pockets of opportunity to be found. 

Most of the time, an investor’s bond portion is implemented by buying huge passive products, predominantly focused on developed market issuers. These products are optimised for simplicity — they lend to a wide range of borrowers without reference to their credit worthiness or the level of interest they are paying. 

Currently, a staggering 30% of developed government bond issuance offers negative yields, requiring investors to pay for the privilege of lending to them. At the same time, large, stable companies have never offered less compensation for the extra risk taken in lending to them instead — if we’re following in the tradition of a typical fixed income portfolio breakdown, this what investors would end up buying. 

In addition to low yields, fixed income markets have also become far more highly correlated to equity markets due to central bank intervention. This means investors can no longer rely on traditional bonds for their diversification needs.

All of this should be leading you to ask, why not break with tradition and think differently? 

Pockets of opportunity 

We’re currently positioned to take advantage of the US residential mortgage space. US consumers have never had so much cash in their pockets or a house that is worth so much. Combine this with mortgage rates being at an all-time low and you create the perfect backdrop for re-mortgage activity. People either want to stay where they are and pay less, or move onwards and upwards. 

To take advantage of this trend we’re invested in the Angel Oaks Multi-Strategy Income Fund, which directly benefits every time someone repays their mortgage. This is currently providing an extra 2% yield over what you receive when lending to a corporate. 

Investors should also be prepared to look outside of the main passive indices. One area of opportunity in this regard is lending to European banks. Regulators insist that banks issue special ‘additional tier one’ bonds, to protect the financial system. Because these bonds are a bit different, they aren’t eligible for the traditional indices, and because they are a little bit harder to analyse, many investors have shied away from them. 

However, it is worth making that extra effort with what’s on offer — well-capitalised, low-risk national champion banks paying 2% more on this debt than what their traditional bonds are paying.