(Bloomberg) -- Corporate bonds are likely to outstrip Treasuries for a seventh straight year as the market steadies and elevated interest rates bolster returns, according to Vanguard Group Inc.
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“Yields are attractive compared with those observed since the 2008 global financial crisis,” the asset manager’s fixed-income team, led by Sara Devereux, wrote in a report Monday. “Relative to history, we are back to a more normal fixed income regime. Investors should recognize that there is a real deal in bonds.”
US bonds have higher starting yields than government bonds across sectors, offering investors the prospect of steady income, and that should aid them in outperforming, according to the world’s second largest asset manager. Vanguard oversees the $122 billion BND, a fixed income exchange-traded fund which stands to gain from inflows into debt.
How far tariffs, fiscal policy and deregulation will go are all overhangs for investors, as is how the Federal Reserve will navigate monetary policy. Despite the unpredictability of the new US administration, Vanguard sees a favorable environment for fixed income, with bonds positioned to perform well through a variety of scenarios.
“While our base case outlook is positive, we emphasize that the uncertainty created by the incoming administration creates a broader range of potential outcomes for growth, inflation, and monetary policy, both domestically and abroad,” the Vanguard team said in the report.
In high-grade bonds, the team is overweight on debt from the industrials sector rated in the lowest tier of investment-grade. It’s also overweight shorter-maturity bonds. The team said it prefers credit sectors that have lagged in spread tightening.
As for high-yield, the team said it still holds a lower-than-average allocation. Investors have piled into junk-rated bonds driving positive returns in two of the past three months, including January so far, since Vanguard’s underweight call in late October. With the asset class’ spreads reaching historical tights, Vanguard says there’s “limited room to absorb negative surprises.” And as the new administration settles in, the team is anticipating increased volatility through fixed income.
But that volatility will likely offer opportunities for investors to add credit risk to their portfolios, if credit fundamentals stay healthy, Vanguard argues.