Why Invest In Bonds Now?
Since I have been in this business, I have heard this question asked of every other asset class. Now it is bonds turn to defend itself against the heard. I remember when I got in investment management business in the late nineties most everyone thought poorly of gold. And asked: "why buy gold? There is no point." Then 15 years later, after gold had quadrupled in price there were "we buy gold" stores popping up all over Atlanta.
In light of the recent performance headwinds, we have recently fielded many questions regarding fixed income and I hope to provide a little additional perspective on the recent results.
This quarter was certainly a bad period for fixed income investments. As new information came to light, markets adjusted rapidly to reflect the new reality and anticipated path forward related to interest rates. In order to stave off sustained inflation threats, central banks will have to move more aggressively to tighten monetary conditions than anyone previously anticipated.
As noted earlier, while I don’t believe any human can predict short-term fixed income market movements any more than we can predict equity market results, my view based on my research and experience, indicate that this resetting of expectations is now mostly, if not fully, priced into the markets.
At this point, it’s important to revisit why we hold fixed income in portfolios to begin with. We believe fixed income has three primary roles in a portfolio:
- Capital Preservation
- Diversification (in particular against equity risks)
- Generate Returns/Income
While the current drawdown in fixed income is meaningful, it pales in comparison to the downside potential of risk assets. As an example, the below chart shows historical drawdowns for stocks and bonds. While bonds are not immune to periodic drawdowns, overtime, they have performed as the ballast we expect.
Bonds often shine their brightest during times of economic difficulty such as recessions or market crises like the Global Financial Crisis or the Covid Pandemic decline in 2020. The illustration below highlights the performance of stocks and bonds during recessionary periods going back to the great depression. On average, bonds have held up better and offset weakness in equity holdings during these periods and have generated positive returns in every period.
Generate returns/income. As shown in the below illustration, bonds have historically generated positive total returns over the vast majority of 2-year periods. While the current period ranks among the worst historical periods for bonds, much like equities, poor performance periods are often followed by better results. One benefit of the increase in rates is that coupon payments and proceeds from maturing bonds can be reinvested at higher rates leading to higher expected returns looking forward.
While the short-term results in fixed income have been challenging, the long-term fundamental benefits from allocating to fixed income in a diversified portfolio remain in place.
FREE RETIREMENT READY SUCCESS CALL
If you would like us to give you a second opinion on your portfolio and how bonds fit in, then click on this link to set up a free, 20-minute retirement rate success call. There's no obligation. We'll take a look at your fixed income assets, and at the end of the call, we'll decide if we’d like to talk again. https://calendly.com/thomascloud/retirement-ready-success-call