Bonds are doing a much better job of fulfilling their humdrum but crucial role of providing portfolios with stable income.
asserted
Bonds → do → income
“There’s this massive shift in the fixed-income landscape,” says Eric Savoie, senior investment strategist at RBC Global Asset Management.
asserted
Savoie → ’ → Management
“Yields are back to levels we haven’t seen in decades.”
asserted
we → see → decades
Expect bond yields to contribute much more to income and returns than they did in the low interest rate era that characterized much of the past two decades.
asserted
that → expect → decades
Investment-grade bonds also provide stability and help cushion portfolios in the event of a sharp stock downturn.
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bonds → provide → downturn
“Bonds can do a lot more heavy lifting given where yields are,” says Matt Wrzesniewsky, head of fixed income client portfolio management at Vanguard Group, a major global investment firm.
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Wrzesniewsky → do → Group
“We would say yield is destiny.
asserted
yield → say → ?
It’s really the engine of a bond and your return is very much aligned with that.”
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return → ’ → that
Bonds hit a milestone earlier this month when the yield on the benchmark U.S. 10-year Treasury bond reached 5.36 per cent — the highest since 2002 — before falling back modestly.
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yield → hit → 2002
Higher bond yields are a global trend, but have risen more in the U.S. than Canada.
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yields → rise → Canada
The broad Canadian investment-grade bond market yielded around four per cent as of late last week, while the U.S. investment-grade market yielded close to 5.4 per cent.
asserted
market → yield → cent
(Those figures are for the particular yield metric known as “yield-to-maturity” and vary somewhat depending on the index used for each market.)
Rising rates come with a painful adjustment
Although bond investors crave higher interest rates, the process of getting there can be unpleasant.
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process → know → rates
Bond prices move inversely to interest rate changes.
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prices → move → changes
As rates rose in recent months, bond investments absorbed a one-time hit to their valuations — enough, in some cases, to produce an overall loss on recent bond fund statements.
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investments → rise → statements
Once interest rates stabilize at a higher level, then the one-time price hit is behind you.
asserted
hit → stabilize → you
From there, you reap the rewards as the higher level of interest payments accumulate over time.
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level → reap → time
“You get a painful experience adjusting to higher yields,” Savoie says.
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Savoie → get → yields
“But once you’re there, the benefits do exist.”
asserted
benefits → ’re → ?
If interest rates ease, you might even see a modest price gain.
uncertain
you → ease → gain
Conversely, if interest rates rise further, then bond prices could suffer more.
uncertain
prices → rise → ?
For that reason, many experts advise sticking mainly with short- and intermediate-term bonds in the mainstream of the investment-grade bond market — avoiding the higher interest rate risk associated with exceptionally long-term bonds should rates continue to rise.
asserted
rates → advise → bonds
As noted U.S. bond investor Dan Fuss of Loomis Sayles told Barron’s investment magazine recently: “It would take a team of oxen to make me buy a 20-year bond.”
Return to the ‘old normal’ of higher yields
Some factors driving higher interest rates are likely to be transitory — such as the Middle East conflict pushing up energy prices and inflation — but others continue to grow, especially the global government debt binge.
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others → note → prices
Most economists expect as a net impact that interest rates will remain relatively high for the next few years compared to the norm of the past two decades.
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rates → expect → decades
“It’s clear that we’ve now escaped this low-interest environment that we’ve been in for most of the post-financial crisis period (after 2008-2009) where rates were rock bottom,” Savoie says.
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Savoie → ’ → 2008
But the higher-rate trend isn’t a “new” normality, Savoie adds.
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Savoie → add → ?
“Probably we’re just going back to what was the ‘old normal.’
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what → go → ?
These yields are more in line with the averages that we’ve seen over the course of a very long history.
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we → see → history
Smart bond investing requires balance
Relative prospects appear to have shifted somewhat from stocks toward bonds.
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prospects → require → bonds
While bond yields have improved, much of the stock market has reached exceptionally high valuations.
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much → improve → valuations
Set a long-term target asset allocation between stocks and bonds that reflects your individual objectives, risk tolerance, time horizon and other personal factors.
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that → set → objectives
While 60 per cent equities and 40 per cent bonds is a classic long-term asset mix that suits many investors, the optimal mix for individual investors can vary widely.
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mix → suit → investors
Many investors make short-term “tactical” adjustments to their asset mix to reflect current market conditions, resulting in a divergence from the long-term target.
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investors → make → target
During the low-rate era, many held fewer bonds and more stocks than their long-term asset mix suggested.
uncertain
mix → hold → bonds
If recent stock market gains have pushed your stock holdings well above target — or if you’ve gone light on bonds because of past low yields — now might be a good time to rebalance and bring your bond allocation in line with your long-term target.
uncertain
time → push → target
Diversify beyond Canada
Traditionally, many Canadian investors have concentrated fixed-income holdings heavily in Canada.
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investors → diversify → Canada
With U.S. bond yields currently much higher than Canadian ones, now is a good time to consider shifting some of your fixed-income holdings to U.S. or global bond funds and ETFs.
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time → consider → funds
When doing so, consider a U.S. or global bond investment hedged to the Canadian dollar, which protects you from adverse currency movements.
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which → do → movements
“Global diversification in fixed income is typically a very powerful feature of fixed-income investing,” Wrzesniewsky says.
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Wrzesniewsky → fix → investing
One attractive aspect of the current environment is that you can earn relatively strong yields in the mainstream of the investment-grade bond market without needing to “reach for yield” with riskier strategies.
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you → earn → strategies
High-yield bonds offer sizable yields but come with considerable credit risk.
asserted
bonds → offer → risk
…and 5 more, not listed.
The Aporia
