Bond yields are low, historically low. Yields on government bonds in the U.S, Europe, Japan and beyond are at seriously depressed levels. Even corporate bonds are reaching multi-decade lows as more investors pour into this asset class. Extremely low interest rates are a double whammy of bad news for bond investors. Not only does it mean that returns will be lower than they were in the past, but
investors should also prepare for an increase in the volatility of bond prices.
What’s an investor to do in this low rate world? Here are a few considerations.
1. Understand why you’re invested in bonds in the first place. Bonds can still soften the blow from an equity bear market, even at lower rate.
2. Look to diversify your fixed income allocation. Bonds have basically been a one-decision asset class since the early 1980’s. It didn’t really matter where you invested because high quality fixed income in the U.S has provided phenomenal returns for such a safe asset class. It probably makes sense to look beyond the traditional bond category and diversify more broadly to include assets such as high quality mortgage backed securities as we have for our clients (Holdun Income Fund).
3. Reset your expectations. The next cycle in the bond market will not resemble the last one. At such low yields it’s obvious that returns will be lower going forward and volatility will be higher. Investors should prepare themselves for both.
4. Your total portfolio matters most, not just the bonds within it. For a diversified investor, the main source of risk and return over the long term is equities, while the role of bonds is to narrow the dispersion of potential returns. Diversified fixed income exposure remains a prudent complement to equities. Even when interest rates rise, what matters most for loss-averse investors is the return of their total portfolio, not just the returns of the bond portion of their portfolio.
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