Beyond Bulls & Bears

Fixed Income

Quick Thoughts: Defensive on the Curve

Stephen Dover shares insights on investing in fixed income in a rising-rate environment with Walter Kilcullen, Head of US High Yield for Western Asset Management, and Reema Agarwal, Head of Floating Rate Debt for Franklin Templeton Fixed Income.

To gain insights on investing in fixed income in a rising-rate environment, I sat down with Walter Kilcullen, Head of US High Yield for Western Asset Management, and Reema Agarwal, Head of Floating Rate Debt for Franklin Templeton Fixed Income. Here are some highlights of our conversation.

With the characteristics of low duration, lower volatility, and higher income versus other fixed income asset classes, we believe a mix of short-term high yield and floating rate debt may provide investors some level of defense in a rising interest-rate environment.

  • The short-term high yield and floating rate loan markets may provide opportunities as interest rates rise. These asset classes are buoyed by relatively low default rates, mid- to late-cycle economic growth and strong inflows.
  • The composition of the high yield market has moved toward higher credit quality with opportunities for ratings upgrades. Higher-rated BB debt was 36% of the total US market in 2007 and has increased to 53% today.1 This is partially due to the “fallen angels” effect where higher-quality companies saw their ratings decline after various crises and become “rising stars” during recoveries. Lower default rates have also been a factor, currently at about 1% versus a historical average of 4.5%. An additional indication of improving credit quality is that approximately 70% of new issuance is being used to retire existing debt.2
  • Floating rate loans (bank loans) provide investors higher income as interest rates rise. The yields on these instruments are pegged to short-term rates, creating a very low duration. This had led to strong inflows, coupled with default rates near 0.3% versus 3.5% on average and bank loans being secured at the top of the capital structure.3
  • Beware of individual company default risk to maximize returns and minimize risk. The dynamics of the floating rate market create opportunities to participate in the positive aspects of the asset class through careful security selection. For the high-yield market, we believe volatility like we’ve seen in the early part of 2022 provides opportunity, as the attractive fundamental aspects of the underlying securities don’t generally fluctuate so quickly.

What Are the Risks?

All investments involve risks, including possible loss of principal. The value of investments can go down as well as up, and investors may not get back the full amount invested. Bond prices generally move in the opposite direction of interest rates. Thus, as prices of bonds in an investment portfolio adjust to a rise in interest rates, the value of the portfolio may decline. Investments in lower-rated bonds include higher risk of default and loss of principal. Floating-rate loans and debt securities tend to be rated below investment grade. Investing in higher-yielding, lower-rated, floating-rate loans and debt securities involves greater risk of default, which could result in loss of principal—a risk that may be heightened in a slowing economy. Interest earned on floating-rate loans varies with changes in prevailing interest rates. Therefore, while floating-rate loans offer higher interest income when interest rates rise, they will also generate less income when interest rates decline. Changes in the financial strength of a bond issuer or in a bond’s credit rating may affect its value.

Important Legal Information

This material is intended to be of general interest only and should not be construed as individual investment advice or a recommendation or solicitation to buy, sell or hold any security or to adopt any investment strategy. It does not constitute legal or tax advice. This material may not be reproduced, distributed or published without prior written permission from Franklin Templeton.

The views expressed are those of the investment manager and the comments, opinions and analyses are rendered as at publication date and may change without notice. The underlying assumptions and these views are subject to change based on market and other conditions and may differ from other portfolio managers or of the firm as a whole. The information provided in this material is not intended as a complete analysis of every material fact regarding any country, region or market. There is no assurance that any prediction, projection or forecast on the economy, stock market, bond market or the economic trends of the markets will be realized. The value of investments and the income from them can go down as well as up and you may not get back the full amount that you invested. Past performance is not necessarily indicative nor a guarantee of future performance. All investments involve risks, including possible loss of principal.

Any research and analysis contained in this material has been procured by Franklin Templeton for its own purposes and may be acted upon in that connection and, as such, is provided to you incidentally. Data from third party sources may have been used in the preparation of this material and Franklin Templeton (“FT”) has not independently verified, validated or audited such data.  Although information has been obtained from sources that Franklin Templeton believes to be reliable, no guarantee can be given as to its accuracy and such information may be incomplete or condensed and may be subject to change at any time without notice. The mention of any individual securities should neither constitute nor be construed as a recommendation to purchase, hold or sell any securities, and the information provided regarding such individual securities (if any) is not a sufficient basis upon which to make an investment decision. FT accepts no liability whatsoever for any loss arising from use of this information and reliance upon the comments, opinions and analyses in the material is at the sole discretion of the user.

Products, services and information may not be available in all jurisdictions and are offered outside the U.S. by other FT affiliates and/or their distributors as local laws and regulation permits. Please consult your own financial professional or Franklin Templeton institutional contact for further information on availability of products and services in your jurisdiction.

Issued in the U.S. by Franklin Distributors, LLC, One Franklin Parkway, San Mateo, California 94403-1906, (800) DIAL BEN/342-5236, – Franklin Distributors, LLC, member FINRA/SIPC, is the principal distributor of Franklin Templeton U.S. registered products, which are not FDIC insured; may lose value; and are not bank guaranteed and are available only in jurisdictions where an offer or solicitation of such products is permitted under applicable laws and regulation.

CFA® and Chartered Financial Analyst® are trademarks owned by CFA Institute.


1.  Sources:  Bloomberg and Barclays, January 31, 2022.

2. Source: S&P Global Market Intelligence, January 31, 2022.

3.  Sources: Ibid.

Get Content Alerts in My Inbox

Receive email alerts when a new blog is posted.