Played Out. Priced In. Now What? A Hedged Income Playbook
Many fixed income investments have had their run. The market has already priced in significant rate cuts. The question is, now what? We believe a rebalance makes sense. In this article we lay out a “Played out. Priced in” problem and make an argument for alternative strategies as part of the solution.
In recent years, investors taking advantage of attractive yields, stability and capital gains have put their trust in cash-like instruments such as cash, Guaranteed Investment Certificates (GICs), and short-duration single-name bonds. As rates peaked, these products thrived, and afforded attractive returns with minimal risk.
However, the tide is turning. As central banks shift their policies and lower rates, the yield potential of these instruments has declined from recent highs. GIC rates for example, once above 5%, are trending down at a steep pace and will likely tumble below 3% in 2025.
Once favoured by investors for their attractive yields and tax-efficient gains, short duration bonds are now trading back near par (Figure 2). The opportunity set in discount bonds has mostly disappeared.
As of September 24, 2024, the market has priced in 175 bps of rate cuts over the next 12 months (Figure 3). This is equivalent to 7 rate cuts, which makes a total of 250 bps of easing when adding the 75 bps of cuts the Bank of Canada has made already this year. Market expectations reflect a cooling economy and falling inflation.
Some investors, hoping to benefit from future rate cuts, are extending the duration of their fixed income portfolios with longer-dated bonds. However, the market has already priced in that number of cuts, so unless the economy experiences a severe downturn, we believe the potential gains from taking on additional duration risk is limited. In fact, even if these rate cuts materialize, our analysis suggests the 10-year government bond yield may actually rise from here, as the yield curve normalizes and gets back to a positive slope.
While the rate market points to a slowdown, the credit market is pricing in a soft landing scenario, with spreads continuing to trade near their historical lows in both investment grade and high yield. This makes allocations to traditional long-only credit challenging here given sensitivity to credit spreads.
As cash, GICs and Discounted Bonds lose their luster and further rate cuts loom, where should investors turn to find sustainable income, attractive return potential and stability? Here, we outline our thoughts and considerations alongside the most common fixed income segments for potential allocations.
The landscape for income investors has changed. It’s time to move beyond the limitations of cash and embrace solutions that are prepared for what comes next.
This material has been published by Picton Mahoney Asset Management (“PMAM”) on November 13, 2024
It is provided as a general source of information, is subject to change without notification and should not be construed as investment advice. This material should not be relied upon for any investment decision and is not a recommendation, solicitation or offering of any security in any jurisdiction. The information contained in this material has been obtained from sources believed reliable, however, the accuracy and/or completeness of the information is not guaranteed by PMAM, nor does PMAM assume any responsibility or liability whatsoever. All investments involve risk and may lose value. This information is not intended to provide financial, investment, tax, legal or accounting advice specific to any person, and should not be relied upon in that regard. Tax, investment and all other decisions should be made, as appropriate, only with guidance from a qualified professional.
This material may contain “forward-looking information” that is not purely historical in nature. These forward-looking statements are based upon the reasonable beliefs of PMAM as of the date they are made. PMAM assumes no duty, and does not undertake, to update any forward-looking statement. Forward-looking statements are not guarantees of future performance, are subject to numerous assumptions and involve inherent risks and uncertainties about general economic factors which change over time. There is no guarantee that any forward-looking statements will come to pass. We caution you not to place undue reliance on these statements, as a number of important factors could cause actual events or results to differ materially from those expressed or implied in any forward-looking statement made.
Commissions, trailing commissions, management fees, performance fees and expenses all may be associated with mutual fund investments. Please read the prospectus before investing. The indicated rates of return are the historical annual compounded total returns including changes in unit value and reinvestment of all distributions and do not take into account sales, redemption, distribution or optional charges or income taxes payable by any unitholder that would have reduced returns. Mutual funds are not guaranteed, their values change frequently and past performance may not be repeated. Alternative mutual funds can only be purchased through a registered dealer and are available only in those jurisdictions where they may be lawfully offered for sale.
There is no guarantee that a hedging strategy will be effective or achieve its intended effect. The use of derivatives or short selling carries several risks which may restrict a strategy in realizing its profits, limiting its losses, or, which cause a strategy to realize or magnify losses. There may additional costs and expenses associated with the use of derivatives and short selling in a hedging strategy.
This material is confidential and is intended for use by accredited investors or permitted clients in Canada only. Any review, re-transmission, dissemination or other use of this information by persons or entities other than the intended recipient is prohibited.
© 2025 Picton Mahoney Asset Management. All rights reserved.
