Fixed income investing ideas for a mild recession

Themes to enact in your portfolio

US Treasury bonds continue to play an important role in diversifying equity risk. But consider shorter duration Treasuries and/or Treasury Inflation-Protected Securities (TIPS) as alternate sources of safety and liquidity. This can help performance in episodic stock/bond correlation spikes.

Non-US sovereign bonds offer higher yields than in recent years, and countries such as the UK and Australia are competitive with the US. Developed international and emerging market bonds can diversify your sovereign bond exposure and outperform amid any additional dollar weakness. This is particularly worthy of consideration for investors with minimal exposure to currency in their equity sleeve.

In credit, recessions present risks and opportunities. Credit often rebounds earlier than the equities as recession fears subside, so the classic recession playbook would say to re-risk through credit before re-risking through equities. Also, outperformance in a recovery can more than offset any underperformance from rising spreads in a drawdown. With uncertain timing, don’t abandon credit, just make sure that your positions are sized appropriately.

Finally, consider dynamic strategies over static positions. Diversified bond categories (e.g., core plus, nontraditional, and multisector) provide an important advantage over pure-play asset categories (e.g., Treasuries, corporate bonds, or high yield). If you’re investing in only pure-play asset categories, then you’re the one forced to be dynamic. Diversified asset categories allow you to outsource to skilled portfolio managers monitoring markets in real time.

Implementation ideas

There are countless ways to implement these themes, largely dependent on your starting point and funding source. In many cases, preparing for a recession could involve improving quality. Two ways of adding to quality are trimming equity and adding to return-seeking fixed income, or trimming return-seeking fixed income and adding to defensive fixed income.

Preparing for a recession could also involve making your portfolio more dynamic. For example, high yield or bank loan allocations could be redeployed into nontraditional or multisector strategies. These more diversified categories can opportunistically invest in a variety of fixed income sectors, including high yield, with the ability to flex risk posture as conditions evolve. Alternatively, core bond allocations could be shifted into core plus. This moves away from a concentrated bet on falling Treasury yields and introduces exposures that can enhance yield or provide alternative sources of downside protection.

Recessions create additional uncertainty, and uncertainty provides both risk and opportunity. We might not have a playbook for navigating an environment that will inevitably unfold differently than past recessions, but building a quality, dynamic fixed income portfolio can at least put your best players on the field.