Market Intelligence October 2017
PIMCO, a sub-advisor we admire for their insightful and deep research capabilities, published a series of charts demonstrating why bonds can play an important role in a diversified portfolio. With central banks keeping interest rates low and the prospect of low future returns if rates rise, bonds are still important diversifiers. Here are three important reasons why bonds may be essential to your portfolio strategy:
1. Bond declines have tended to be modest and short-lived: Bonds have historically been used for capital preservation, income, and diversification due to their low-to-negative correlations to stocks – essential goals for many investors. Bonds, particularly core bonds, have also been less volatile than stocks. As the chart above shows, bond declines have been dramatically less severe than stock declines and recover in a fraction of the time.
2. Rising rates build income: Because interest income is the primary driver of bond returns, the ability to reinvest into a gradually rising rate environment has the potential to help build long-term growth. When rates rise, new bonds pay a higher coupon, increasing the income investors receive. An increase in a bond portfolio’s income also helps to offset the negative impact on its declining price. Over time, rising income may provide a return benefit for investors.
3. Rising rates don’t impact all bonds the same: News about the bond market typically focuses on U.S. Treasuries, which tend to be the most sensitive to changing rates. In reality, the bond market is exceedingly diverse and global, and each sector or asset class responds differently to economic and market trends. The chart below shows that some, such as floating rate and high yield bonds, actually have tended to do well in a rising rate environment.
Helping you achieve your financial goals is our main focus. Because bonds are structurally different than stocks (they have set payment dates, maturities, credit profiles, and are higher up the capital structure), they don’t behave in the same manner. So whether you’re preparing to retire, want to guard against the next market correction, or protect the wealth you’ve worked so hard to accumulate, bonds can provide income, diversification and stability in various rising rate environments.