Unleashing the Potential: Fixed Income for Stock-like Returns

Investors love fixed income because the coupons are generally fixed. Buying a bond provides steady payments to the holder and that drives the underlying return. Investors tend to look toward equities to provide capital gains for their portfolios.

But what if the relationship is now flipped?

These days, the fixed income side of the equation could provide some very stock-like returns. That’s the gist according to a new J.P. Morgan Wealth Management study. Thanks to a variety of factors, bonds could now be the total return element for portfolios. For investors, that could mean overweighting fixed income and rebalancing their portfolios accordingly.

Falling Prices, Higher Bond Yields

We all know the Federal Reserve has spent the better part of a year fighting inflation. And with that, the central bank has continued to raise interest rates. Going from zero to 5.25% has had a dramatic effect on bond pricing. Bonds have an inverse relationship with interest rates. Prices for bonds currently on the market will fall to reflect the higher rate and match newly issued bonds with higher coupons. This inverse relationship is why the broader Bloomberg U.S. Aggregate Bond Index tanked by over 13% last year and recorded its worst return ever.

But according to J.P. Morgan (JPM), the worst return for bonds in over 250 years could light a fire under the sector and provide something fixed income isn’t normally known for: equity-like returns.

JPM predicts that investors in bonds can achieve returns in fixed income investments that are comparable to the S&P 500 since the year 2000 or roughly 6.7% annually. Better still is that investors can get those returns with less volatility than stocks. The key is a combination of several factors driving those returns.

How We Get That Return

For starters, the investment bank highlights the overall higher yields on fixed income investments and bonds. With the drop in prices and the Fed’s path to higher interest rates, bonds are doing something that they haven’t done in years: provide actual income. JPM highlights that cash and short-term bonds are now paying close to 5%, while corporates, junk bonds, and hybrids like preferred stock are paying nearly 7%. These ‘guaranteed’ cash-in-hand payments drive a lot of fixed income’s returns. Over time, higher starting yields have provided better long-term returns for portfolios.

Second, JPM sees potential price increases for bonds. While chances of a recession are rising, the Fed may very well pull off a soft landing for the economy. Under either scenario—a pause in rate hikes or a cut to reignite growth—would be positive for bond pricing. Again, the inverse relationship works in the other direction as well. Right now, credit spreads are wider than historical averages. This implies that bonds are cheap and will provide enough price gains when/if recession comes and the Fed starts pausing/cutting rates. Given the slowdown in inflation and deterioration of other key economic data, JPM predicts that the Fed could be near the end of the tightening cycle.

The combination provides the ability of bonds to function and provide stock-like total returns for a portfolio.

J.P. Morgan’s Recommendations

Not all bonds are alike and for JPM just buying a fund like the iShares Core U.S. Aggregate Bond ETF (AGG) isn’t necessarily a great option for investors. The investment bank makes some specific recommendations for its clients in the core carry/ballast and hybrid sectors to achieve the best blend of stock-like returns.

For investor’s core, JPM highlights municipal bonds and short-duration investment-grade corporate bonds as the best place for income. Both segments offer yields in the 4% to 5% range these days, with munis offering plenty of after-tax benefits. JPM offers several funds in these areas, including the actively managed and low-cost JPMorgan Ultra-Short Income ETF, JPMorgan Ultra-Short Municipal Income ETF, and JPMorgan Municipal ETF.

For hybrids, JPM suggests that preferreds and convertible bonds offer compelling yields of around 7% and the potential for capital appreciation. Credit spreads for the sector are currently around 400 basis points. Historically, that’s provided an average one-year forward excess total return of 20% for the segment. When spreads are 300 basis points, the excess total return is still 13%. The JPMorgan Preferred and Income Securities Fund offers exposure to both preferred and convertible bonds.

Some of the Top Performing J.P. Morgan Fixed Income Funds

Investors have plenty of other choices outside of JPM’s funds to complete the same concept. For example, the iShares Short Maturity Municipal Bond ETF and Global X US Preferred ETF can be used instead of the comparable JPM funds.

Another choice?

Let someone else do it for you. Total Return bond funds are basically designed to provide both income and capital gains. The PIMCO Total Return Fund remains the gold standard in the category, while the SPDR DoubleLine Total Return ETF offers a similar strategy in an ETF wrapper.

Other FIxed Income Funds to Consider

The Bottom Line

With bond prices low and yields high, fixed income investments could be very stock-like going forward. For investors, that means positioning themselves accordingly. As JPM suggests going short, owning munis, and focusing on hybrids like preferred stock could be the best ways to generate those stock-like returns this year.