Why do you invest in fixed income? When I entered the fixed income business 25 years ago, the most popular answers would have been:

To generate income while preserving capital.

Or

To generate income while matching return of principal to expected actuarial needs (expected liabilities).

Ask this question today and you might get an answer, such as:

To have a negative correlation to equities to protect my portfolio balance in case equity price decline.

Would you answer the question;

Why do you eat vegetables?

With

To offset the impact of meat?

Of course not. When you eat, you diversify among food groups so the all contribute to a positive outcome. However, each food/food group benefits in a different way.

Since the meteoric rise of Modern Portfolio Theory and Unified Managed Accounts during the past decade, the original purpose of fixed income investments have become lost. MPT and UMA have transformed everything into meat, the total return portion of a portfolio. Most (if not all) UMA portfolios view all assets as a total return holding. When returns or the various asset classes change, the portfolio is rebalanced. Few UMA/MPT portfolios offer actual bonds. Thus, most UMA portfolios are akin to a diet of chicken, beef and pork. It appears diversified, but it really isn’t. Missing are the fruit, vegetables and grains.

The wealth management firms are keenly aware of the fact that UMA portfolios are, in some ways, investment diet deficient. This is why they often tell advisors and investors half-truths and outright prevarications, such as, one cannot buy individual bonds as cheaply as a professional manager”, or “odd-lot bond purchases are more difficult to transact due to their small size.”

There was some truth to this in the past, but advancements in technology, such as the rise of electronic communications networks (ECNs) and the implementation or bond execution reporting platforms, such as TRACE and MRSB pricing, have leveled the playing field considerably. The improved bond price clarity has narrowed bid/ask spreads. The result is often little differentiation between odd-lot and round lot pricing. Another playing field leveler are new financial regulations which limit banks in the area of proprietary trading.