How to create a diversified bond portfolio with up to 6% yield
Rising yields were one of last year’s major themes as bonds crept into a bear market. Yields on the 10-year Treasury shot up to as much as the 5% mark in October — a 16-year high — but has since dropped to just above the 4% level. Yields and prices move in opposite directions. But in recent months, many have called for investors to return to bonds as prices are expected to recover soon. Falling yields may prompt investors to wonder which corners of the fixed income market still offer higher yields of up to 6%. Brandon Huang, head of fixed income at LGT Private Banking Asia, says 2024 will be the year when bonds will provide a “reasonable risk-adjusted return amid a normalized yield environment.” “Inflation has come down in the US and this will allow the Fed to reduce the policy rate in the middle of this year. We conclude that investment grade bonds are compelling after looking at the historical behaviour of different asset classes around rate cuts,” he told CNBC Pro. He urged investors to “lock in yields” right now. “The yields available now after the repricing in 2022 will arguably not last,” he said. Huang says that if 10-year Treasury yields drop to 3.75%, investment-grade bonds may return 6% or more over the next 12 months — 5% from coupon income and the rest from price appreciation as rates fall. He prefers developed market bonds — especially the U.S. — to emerging market bonds, of longer durations exceeding seven years. Sector-wise, he likes financials, specifically dated subordinated tier 2 bonds from Australia that may be in line for credit rating upgrades. Subordinated tier 2 bonds are paid back after senior debt has been settled in the event of bankruptcy. Investors can also get yields of above 6% in non-investment-grade or emerging market bonds, but Huang “urges caution.” “Investors are arguably not compensated sufficiently for the incremental risk taken over and above investment grade bonds,” he said. “If allocating to non-investment grade bonds, we would prefer issuers with improving balance sheets or issuers with business operations that are expected to perform strongly,” he added. Remi Olu-Pitan, head of multi-asset growth and income at Schroders, told CNBC Pro that mortgage-backed securities can yield about 5.5% now and “at a stretch 6%,” citing Fannie Mae and Freddie Mac in the U.S. as examples of such agencies. Those mortgage-backed securities are debt obligations issued by agencies whose cash flows are tied to the interest and payment on a pool of mortgage loans. Agency MBS have low credit risk because they are backed by the U.S. government. If investors are willing to take on more risk, Olu-Pitan says, non-agency MBS are yielding about 7% to 7.8% now. However, they aren’t guaranteed by the U.S. government. Here are some mortgage-backed securities exchange-traded funds to consider. Emerging market debt can also offer high yield because of the very high real rates in many such economies, Olu-Pitan says, with Latin America debt offering “easily” above 7%. In investment-grade bonds, investors can get above 6% in U.S. financials, she added. — CNBC’s Michael Bloom contributed to this report.
