Navigating Fixed-Income Investments in 2024

Interest rates remain high and The Fed has yet to pull the trigger on a rate cut. Meanwhile, a looming U.S. election invites more uncertainty. As macroeconomic pressures and market volatility persist, investors are actively seeking diverse and stable income-generating strategies.

While traditional fixed-income assets have regained attention due to their attractive yields and favorable credit spreads, there is growing interest in alternative avenues that offer comparable stability and additional long-term benefits. US farmland has emerged as a compelling option, offering historically reliable income streams akin to traditional fixed-income assets while presenting the potential for land appreciation and inflation protection.

The Fixed-Income Landscape Amid Peak Interest Rates

With interest rates at their highest in more than a decade, major players are beginning to withdraw hundreds of billions of dollars from the stock market. Calpers, for example, is pulling $25 billion away from stocks as the nation’s largest pension fund recalibrates its portfolio toward more private exposure.

Treasuries

Short-term Treasuries have performed relatively well due to rising yields in response to the Federal Reserve's interest rate hikes aimed at combating inflation; higher yields have attracted investors seeking safer, short-term returns.

Long-term Treasuries, however, have been more volatile given uncertain interest rates and inflation expectations. However, with expectations that interest rates may have peaked, these assets are becoming increasingly attractive, as investors look to lock in higher yields which have risen from lows in previous years. With predictions that the Fed may start reducing rates at the end of this year, the outlook for long-term government securities improves.

Corporate Bonds

Corporate bond investments posted some of the strongest returns in the fixed-income universe in 2023. Notably, lower-rated, higher-risk bonds led the sector. The Bloomberg US High Yield CCC Index, for example, climbed almost 20% during the year, while the Bloomberg US High Yield BB Index rose 11.6%.

Rising interest rates contributed to increased yields, while the robust financial health of many corporations and low default rates provided additional support, resulting in equity-like returns with relatively low volatility. However, it’s important to note that current spreads on corporate bonds are well below their long-term averages, recently falling to the lowest levels since 2007.

Investment-Grade Corporate Bonds

Investment-grade corporate bonds demonstrated moderate performance in 2023 compared to their high-yield counterparts. The Bloomberg U.S. Corporate Bond Index returned 8.52% in 2023, outperforming the Bloomberg U.S. Aggregate Bond and the Bloomberg U.S. Treasury Bill Indices. Currently, the yield on the Bloomberg U.S. Corporate Bond Index stands at around 5%, which is still well above historical averages. As investors seek to add duration in anticipation of falling yields and potential capital gains, investment-grade bonds are expected to become increasingly attractive.

Municipal Bonds

Municipal bonds, currently yielding 3.66%, are expected to remain stable in 2024, supported by the strong fiscal positions of many state and local governments. The tax-exempt status of municipal bonds should continue to be appealing to high-net-worth investors, particularly if higher tax rates are introduced.

Certificates of Deposit (CDs) and Money Market Funds

CDs and Money Market Funds have closely tracked interest rate changes, with potential modest improvements if rates stabilize or decline.

Looking Ahead

Looking ahead, uncertainties regarding economic growth, inflation rates, and the Federal Reserve's future actions may introduce price volatility and tightened spreads in these markets. As we enter the back half of 2024, investors may consider diversifying their fixed-income portfolios to manage risks and seize opportunities in a dynamic market environment.

Farmland in an Income-Generating Strategy

Amidst the diverse performance of fixed-income assets in 2024, farmland investments present a compelling alternative, blending the reliability of income-generating products with the tangible asset security of real estate.

Leased Farmland

Similar to traditional fixed-income investments, leased farmland generates regular income through rental payments, providing a more steady and predictable cash flow. The leased structure tends to shield investors from the operational risks of day-to-day farming and the crops' performance.

Leased row crops, such as corn and soybeans, typically fit into a core fixed-income strategy due to their historically lower risk profile. These crops are planted annually and are often leased on shorter-term agreements, helping to reduce income volatility. As a result, row crops tend to offer modest, yet reliable cash flows, making them an attractive option for investors seeking stable income streams comparable to those from municipal bonds.

In contrast, leased permanent crops, such as almond orchards and vineyards, may fit into a core-plus strategy as these investments tend to offer higher potential returns. While they carry a slightly higher risk, the potential for greater income through higher-value crops makes them suitable for investors willing to take on a bit more risk for higher rewards. In either case, farmland investments can play a valuable role in a fixed-income strategy by providing diversified sources of income and risk.

Appreciation Potential

Unlike bonds, farmland investments offer the potential for capital appreciation over time. Since 2000, the NCREIF Farmland Property Index, which tracks the total performance of U.S. row and permanent cropland (appreciation plus income), has more than tripled. This performance reflects an average annual appreciation rate of around 6%, considerably higher than the returns typically available from bonds, which at most reach par value. It also demonstrates farmland’s ability to deliver stable returns across various economic cycles, the essential nature of food production ensuring that farmland's value remains relatively stable, regardless of broader economic conditions.

Looking forward, farmland values are well-positioned to benefit from factors such as global population growth, increasing food demand, and limited supply of arable land. These market fundamentals create a strong foundation for long-term capital appreciation, a feature that fixed-income investments can’t offer. Farmland’s dual return structure, combining both yield and appreciation, significantly enhances the asset’s appeal as a component of a fixed-income portfolio, providing investors with both income and growth potential.

Inflation Hedge

Farmland investments may also help hedge against inflation, as the value of agricultural products and land typically increases with inflation. The NCREIF Farmland Total Return Index has consistently outpaced the inflation rate since before 1992. Fixed-rate bonds, in contrast, are generally negatively affected by inflation, as rising inflation erodes the purchasing power of the fixed interest payments that bonds provide.

Harnessing Farmland

As investors continue to seek stability, long-term value, and protection against inflation, farmland has emerged as a compelling addition to a fixed-income portfolio.

With its dual return structure, farmland can provide a distinct combination of income generation and growth potential. As part of a diversified fixed-income strategy, farmland can offer both stability and the opportunity for capital appreciation, positioning it as a valuable option for investors navigating evolving economic conditions.