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In many sports, be it hockey, soccer or lacrosse, there is a goalie whose role is almost always to protect the net from the opponent scoring a goal. It’s always an added bonus when the goalie can contribute in other ways to the team's success, like distributing the ball or puck to enhance the team's playmaking ability. However, if this comes at the expense of defending the net – the primary purpose of the goalie – the added contribution is not usually worth the risk.
Fixed income functions similarly to a goalie for your portfolio. Its purpose is to defend the portfolio's value in times of market turmoil by supplying liquidity, diversification and stability. However, times have changed, and the time is right for revaluating how your portfolio's goalie is performing.
Part 2 of 5
The Asset Allocation Team has created a 5-part series of papers that addresses the evolution in our approach to asset allocation. Namely, how the 60/40 portfolio has served investors well in the past, why evolution is needed now more than ever and the approach to asset allocation at TD Asset Management Inc. (TDAM).
Our first paper illustrated that fixed income has been a core part of a balanced solution. The negative correlation with equities has historically given investors a "free lunch", by providing both lower risk with similar returns. However, record low bond yields have not only reduced the return potential of fixed income but also driven investors to search for higher yield, which further weakens the protection it provides.
Fixed income remains a core element - but exposure needs to be adjusted
In Part 2 of our series we highlight how global central bank monetary policies have had a significant and long-lasting impact that will affect all asset classes, but particularly fixed income and its role as a "goalie" for your portfolio. The article highlights how fixed income's role has evolved and how the right solutions can still play an important role in helping investors achieve their investment goals.
With structural changes and a new monetary policy regime, fixed income is expected to have lower yields and potentially lower expected returns for the foreseeable future. Against this backdrop, the role fixed income plays has changed and needs to be adjusted. The allocation to fixed income will need to be reduced within a traditional balanced portfolio, and other sources of diversification will need to be sourced.
Portfolios will always need a goalie
Despite these new challenges, it's important to keep in mind that fixed income’s original task of being your portfolio's goalie hasn’t changed. When fixed income does what it is intended to do, the rest of the portfolio can do its intended job as well. Having well balanced, protective, and liquid fixed income investments allows you to take more risk in search for higher return growth assets like equities and alternatives. Prudent active management within fixed income is even more important now as it can help investors access new return streams and higher yields without taking excessive risk in a search for yield.
Be sure to look for our upcoming articles that include the new ways in which TDAM views and explores a more modern portfolio.
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