In this Q&A, John Kerschner of the Janus Henderson Multi- Sector Income Fund discusses how the Fund can help investors navigate concerns about the impact inflation and rising interest rates could have on bond portfolios and why we think these risks can potentially be mitigated with an actively managed multisector bond portfolio.

Should fixed income investors be worried about inflation?

We are in the camp that inflation will be transitory but believe it will probably run a little higher than the U.S. Federal Reserve (Fed) is predicting over the next year. For one, recent upticks in wages suggest inflation could persist a little longer as workers would have greater purchasing power. Similarly, the upcoming Social Security increase is going to be 5.9%, which is not insignificant and impacts a large demographic. Also, the U.S. printed a record amount of money in 2021 and distributed it to people through various fiscal stimulus programs. That extra money coupled with many asset classes generating gains amid the recovery and rising home prices, could lead people to feel capable of spending a little more or tolerating higher prices. Lastly, over 30% of the Consumer Price Index (CPI) comes from household rent¹. But household rent measures lag, and we expect them to continue putting upward pressure on CPI in the months ahead. And all of this is on the back of a substantial, pandemic-driven supply shock.

Long term, we anticipate a broadly deflationary environment given the structural factors that have generally kept inflation suppressed are still intact: demographic shifts, technology advancements and open borders, to name a few. Inflation may be a risk to the markets in the short term, but we think it will be very hard to have sustained inflationary pressures over the long term.

Where are interest rates going?

The Fed’s plans for tapering its purchases of Treasuries and agency mortgage-backed securities (MBS) take a big buyer out of the market. With that, and if inflation runs a little hotter for a little longer, I do think we could see moderately higher rates. But, like our inflation outlook, in the longer term, we think rates are unlikely to persist at significantly higher levels. As investors around the globe continue to seek sources of income, U.S. government bonds still look attractive relative to low, zero and negative yields elsewhere in the world. The Fed will eventually raise rates and while the timing of these raises is unclear, we expect the terminal fed funds rate to be no higher than the peak reached during the last hiking period (2.50%). Without a substantial, and sustained, increase in the short-term policy rate, it’s hard to see longer-maturity bonds staying at much higher levels.

How does the Multi-Sector Income Fund help investors navigate inflation and interest rate uncertainties?

First, it’s crucial to know your bond benchmark. The yield on the Bloomberg U.S. Aggregate Bond Index, for one, is below 2%². With inflation now over 5% for the last six months on a year-on-year basis, investors are paying a “real” cost (after accounting for inflation) to hold this benchmark. Even if the recent high levels of inflation prove transitory, the market generally expects it will stay above 2% in the coming years. Thus, if the Aggregate benchmark generates income around 1.5% a year, investors will face a real cost of around 0.5% a year. We think investors need flexibility around the Aggregate index to find attractive risk-adjusted returns in this environment.

One of the unique aspects of the Fund is that we have three portfolio managers from disparate fixed income backgrounds debating some of the best opportunities and jointly driving asset allocation decisions. I head our securitized team while Seth Meyer runs our high-yield portfolios, and John Lloyd runs our corporate credit research. This lack of home bias allows us to be dynamic, moving allocations around the various fixed income sectors based on where we think we’ve found the most attractive risk-adjusted return profiles.

Are there still strong opportunities for yield today?

We find the high-yield corporate bond market interesting as it continues to offer some of the most attractive yields in the current environment, along with a typically low sensitivity to rising interest rates. We also think there are opportunities within the range of securitized products. For one, we see value in MBS, particularly relative to the generally lower yields – and greater sensitivity to rising rates – of investment-grade corporate bonds. Also, markets such as commercial mortgage-backed securities have a number of sectors that appear attractive, including those backing medical-related properties or industrial warehousing. Bank loans with floating rate coupons that are relatively insensitive to higher rates also appear attractive. We think the opportunities exist; investors just need to broaden where they look for them.

What type of investor should consider this Fund?

Investors seeking a potentially high and consistent source of monthly income should consider this Fund. Investors mindful of the risks to interest rates and aware of the low yields offered across much of the investment-grade space may find the Fund attractive. Likewise, investors who are attracted to the high income some high-yield funds may offer, but have trouble stomaching the volatility those investments may require, should find our Fund attractive. Our approach is to incorporate multiple levers to help generate yield while still seeking to preserve capital and protect against some of the risks that could be detrimental to a client’s portfolio. Our core tenet is simple: generate sufficient, stable income without taking on substantial risk – even in challenging markets.

¹ Source: Bureau of Labor Statistics, as of 28 October 2021.
² Source: Bloomberg, as of 28 October 2021.