Why picking bonds is as important as picking stocks

Around the proverbial four walls of Livewire, everyone loves to talk about how investors pick the best stocks. It's not just about getting exposure to the Big Four banks, but picking which Big Bank you want to keep in your back pocket for income. The same is said about iron ore miners, consumer companies (buy what people need or buy what people want), and especially technology stocks. 

But just as stock picking has become a key tenet of investing, should picking bonds get the same time investment and attention to detail? Neuberger Berman's Adam Grotzinger firmly agrees.

In this, the first in a brand new series of Expert Insights, Adam shares his thoughts on why bond picking is so important right now and gives you some tips on how to invest in the right bond at the right time. Plus, we'll also talk about the relevance of the 60/40 portfolio and much more. 

Note: This interview was taped on Wednesday, October 13th, 2022. 

LW: Why are bonds having such a tough year?

Adam Grotzinger: It has been a shocker of a year. I mean, one of the worst ever in the bond markets, certainly in my career. We've got here because to start the year, many of the central banks, particularly in the developed market world, in particular, were late and behind the curve to address more sticky inflationary pressures that were thought to be transitory. And the net result of that does not only have interest rates risen and policy rates have risen, but they've had to revise to higher levels of policy rates in a tighter path of tightening to address these inflationary concerns.

LW: Should we have seen this bear market for bonds coming?

Adam Grotzinger: Yes and no. I think the yes part of it would be some of the structural issues that are long-term in nature and really feeding through to these inflationary pulses, have been fairly well understood by our investment teams. Those are the changing in demographics globally, not only in the developed world but what's happening in China and the implications for that on wage pressure. What's happening with regards to supply chains and kind of peak global trade and the shrinkage of that, and that creating bottlenecks in supply. And then what's happening in energy, this desire to transition much of the global economy to greener energy, and all those things are longer term in nature and creating many of these inflationary pulses. The exact timing of when that gets recognised by markets is harder to place a pulse on. But we've certainly gone through that this year with markets recognising the kind of more structural sticky nature of many of these aspects to inflation.

LW: Is a 60/40 portfolio fit for purpose in this environment?

Adam Grotzinger: To be determined. I think that the big question you have to ask yourself is the trajectory of inflation, and do we start to see some plateauing to inflation, and can we see some moderation in some aspects of how inflation's derived? And if we have our sights that yes, that's achievable more medium to long term, know there is I think an understanding that the correlation structure of bonds versus equities can start to come back to more normalise levels that you expect when you're running a 60/40 portfolio. 

So in the short term, those correlation structures are going to be volatile, but on the basis that we can return to some degrees of lower levels of inflation, maybe higher than what we're used to pre-COVID but lower than where we're at now, and coupled with higher interest rates, bonds could start playing not only a powerful role in portfolios but a good diversifier again, more medium term.

LW: We talk a lot about stock picking - but how important is it to pick individual bonds right now?

Adam Grotzinger: Really important, and it's exciting because we haven't been here in a while. We've been in this world of central banks really supporting fixed income markets through policy, extending their support into credit markets during the COVID era. And now that central banks are keen to withdraw that support as a function of a necessity of fighting inflation and tightening policy, tightening financial conditions, markets are beginning to operate normally. So yes, security selection is going to pay an important part. It always has, but I'd say a more important part of the outcome of a bond portfolio. But there are other things in fixed income, more than just picking the bonds that you own. You have to think about what type of duration profile you want for your portfolio.

Do you want less price sensitivity to interest rates or more? So, short versus long duration. You have to think about the regions of the world in which you're investing. Right now we have a very strong preference for the US market, given it's the best of a bad bunch on the macro front, and there's more certainty there from a macro perspective versus other parts of the world. So, what region you're in, where you're at on the yield curve, what type of duration you have, what bonds you're choosing, all very important factors to fixed income results.

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