Fed Rate Cuts Spark Investor Rush to High-Yield Fixed-Income Alternatives

Federal Reserve Rate Cuts Spark Search for Yield in Fixed-Income Investments

As the Federal Reserve’s rate cuts impact returns on traditional fixed-income investments like CDs and money market funds, investors are seeking alternative options to maintain attractive yields. Rick Rieder, Chief Investment Officer of Global Fixed Income at BlackRock, has identified several fixed-income investments that continue to offer premiums over benchmark rates.

Rieder highlights AAA collateralized loan obligations (CLOs) and European credit as particularly attractive investment opportunities in the current market environment. AAA CLOs, which are groups of high-quality bonds packaged together, are trading at a 120 basis-point spread to the Secured Overnight Financing Rate (SOFR) curve, offering substantial yields with low default risk.

European credit, encompassing both investment-grade and high-yield bonds, presents another promising avenue for investors. The stronger euro enhances effective yields when converted to US dollars, with US investors potentially gaining an extra 150 basis points from European credit investments. Rieder notes that European firms have improved their creditworthiness post-pandemic due to lower debt levels, making lending in Europe an attractive proposition.

The iShares Flexible Income Active ETF (BINC), managed by Rieder, exemplifies these investment strategies. With 39% of its holdings in European credit and CLOs, BINC has attracted $6.7 billion in assets since its launch in May 2023, boasting a 5.9% annualized yield. The fund combines high-yield and investment-grade bonds, maintaining an average BBB+ rating and a duration of 2.5 years.

Rieder predicts a “static” interest rate environment if inflation remains high and economic growth continues to be strong. These conditions could limit the Federal Reserve’s ability to cut rates significantly, potentially leading investors to demand higher yields for longer durations.

As the fixed-income landscape evolves, investors are increasingly looking to diversify their portfolios with these alternative investment options to maintain attractive returns in a challenging interest rate environment.