Why Retirement Plans Should Offer True Core Fixed-Income Funds

Historically, high-quality bonds have helped diversified retirement investors temper volatility in their portfolios. Bonds generally experience less price volatility than stocks, which may help smooth out the effects of regular gyrations in equity markets. Additionally, the historically low-performance correlation between stocks and bonds highlights the complementary nature of these asset classes.

Differentiating Between Authentic Core and Core Plus Is Crucial

Given the historical asset class relationships, 2022 was an anomaly year, with most stock and core fixed-income strategies suffering double-digit percentage declines. However, performance dispersion among core fixed-income funds was significant. There was a nearly 4% return difference between the average first-quartile performer and the average fourth-quartile performer in Morningstar’s intermediate core bond category last year.¹

Notable philosophical differences within the core category largely explain 2022’s results. There are genuine, high-quality, core fixed-income offerings, and there are options that take on higher risk and therefore behave more like core plus funds.

The potential advantages of a true core bond fund should persist in the new environment of structurally higher inflation and higher yields. Near-term recession concerns only increase the urgency of re-assessing the core fixed-income alternatives you’re offering to plan participants.

It’s Time to Call Off the ‘Search for Yield’

Stretching into riskier core bond portfolios in retirement plan menus is a strategy of the past. In the 12 years between the financial crisis and the pandemic, bond yields remained unusually low, triggering the search for yield. In today’s structurally higher rate environment, there should be little need for participants to seek creative ways to boost yield and returns.

Instead, we believe high-quality bonds offer attractive opportunities for retirement investors. In general, bond yields are attractive across high-quality sectors and maturities. Today’s economic backdrop and historical bond market performance patterns further support our confidence.

Bond Yields Are Back

Following the financial crisis, most bond yields hovered at or near record lows. The combination of easy monetary policy and low inflation helped keep interest rates at unusually low levels for an extended period.

But all that changed in 2022, as inflation soared, the Federal Reserve (Fed) abruptly and aggressively changed course, and bond yields climbed to multiyear highs. Bonds now offer the highest yields — and the highest income potential — in nearly 15 years, as Figure 1 demonstrates.

Slowing Economy Favors High-Quality Bonds

Although inflation has likely peaked, we believe deglobalization, an aging workforce, a tight labor market and insufficient energy investments are keeping pricing pressures entrenched. Therefore, we expect rates and yields to remain higher than pre-pandemic levels. Additionally, the Fed’s rapid and sharp tightening of monetary policy is increasing recession risk.

As recession takes hold, yields on high-quality bonds, including longer-maturity Treasuries, likely will drop. This should lead to additional positive return potential, beyond the yield, for high-quality bond portfolios with at least a moderate amount of duration.

Today’s higher-yield environment helps restore the diversifying value of high-quality bonds in a recession. Bonds are now viable substitutes for part of an equity allocation, where investors selling risk assets may consider high-quality bonds with meaningful yields as replacements. This inverse demand should help bring correlations between stocks and high-quality bonds back to their historically low levels.

Now’s the Time to Ensure Participants Can Access True Core Fixed Income

We believe most retirement investors could benefit from a core bond allocation to achieve diversification and/or income. As we saw in 2022 and in early 2023, core bond funds that remained “true” core strategies offered incremental value in achieving these objectives.

Over the long run, well-rounded and high-quality bond funds, such as American Century Investment's Diversified Bond Fund, seek to add income to asset allocation strategies. They also strive to deliver superior risk-reduction potential to diversified strategies.

High-Quality Bond Market Exposure

Diversified Bond’s management team seeks the best values among high-quality bonds, including U.S. Treasury, corporate and securitized securities. This broad range of investments gives the fund exposure to various sources of income and total return within the higher-quality universe. It also allows the team to pursue attractive active returns in all market environments.

Volatility Minimizer

Because it generally experiences less price fluctuation than stock funds, Diversified Bond historically has had low correlation to stocks, as Figure 2 demonstrates.

More important, the correlation of Diversified Bond to equities dipped even lower and into negative territory when investors needed it most – during stressed market environments. This dynamic offers the potential to dampen the overall volatility in your plan participants’ portfolios over time.

Compared with its peers, Diversified Bond delivered better risk-adjusted returns for the last 15 years. Figure 3 highlights this record.

We attribute the fund’s risk-adjusted return history to our active management process. Skilled sector specialists research the investable universe to identify what they believe are the best relative values within their areas of expertise. Analysis of the economic and interest rate backdrops, inflation and Fed policy helps inform these decisions.

Equipped with these insights, the team sets the broad duration, yield curve and sector allocations for the fund. Risk management — or seeking to maximize the return consistent with Diversified Bond’s high-quality risk level — remains a primary focus throughout our investment process.

An Outperformer in Stressful Times Versus Similar Strategies

Investors generally expect bonds to offer an element of steadiness during stressful market times. Diversified Bond historically delivered on that expectation more effectively than its peers. The fund consistently outperformed its peers during periods of market unrest over its long track record. See Figure 4.

Figure 4 | Outperforming During Market Unrest

Performance During Periods of Stress

Attractive Income Potential

With interest rates climbing to multidecade highs, we believe Diversified Bond can potentially deliver an attractive, reliable income stream without taking undue risk.

Investors approaching retirement or already in retirement should consider pairing their income needs with strong downside protection. These investors cannot afford to take more risks with their principal to pursue their income needs.

Do You Have the Right Fixed-Income Option in Your Plan?

Performance patterns in 2022 and early 2023 revealed the perils of stretching risk in a fixed-income allocation. With higher yields now available from high-quality fixed income, your retirement plan may have the opportunity to abandon the aggressive pursuit of yield on behalf of your participants. We believe it’s a good time to re-assess your core fixed-income option, confirming that a true high-quality core bond fund remains an option for your participants.

As its name implies, Diversified Bond provides broad exposure to the investment-grade bond market. This genuine core bond fund seeks consistent long-term returns and income, making it an attractive portfolio diversifier. Its focus on relative value, high-quality bonds, intermediate duration and risk management means it’s appropriate for investors pursuing diversification and high-quality retirement income.