The Rate Conundrum: Why Do I Own Bonds?
2020 has been a challenging environment for bond investors. Beginning in the second half of 2019, the 10-year Treasury yield started to decline and reached historically lows levels March of this year (below 1%). In light of the Covid-19 pandemic and Federal Reserve actions, 10-year Treasury yields remain suppressed in a range of 0.50% to 0.75%, and are near zero, or worse, when adjusted for inflation. Despite these challenges, we know bonds have a place in a well-diversified portfolio.
We’ve heard questions from clients over the last few months about why they should still own bonds. Why don’t I just hold cash right now, or should I be reaching for yield in lower-credit-quality investments?
While both of these options might seem tempting, we continue to believe high-quality bonds should serve as the core of your fixed income allocation. In many of these conversations we’ve communicated three key points as reasons to hold bonds today (and into the future):
- Bonds offer diversification benefits not seen from other asset classes. In baking, all ingredients serve a purpose in the recipe just like in portfolio management where all asset classes serve a purpose toward the end goal. During the stock market route in March many bond investments did what was expected during the craze, keeping a more stable value than equities. Historically bond returns have been less correlated with the S&P 500 returns, with U.S. treasuries and municipal bonds having negative correlations over the last 10 years. If the economic recovery were to pause, bonds should help buffer some of the potential stock market decline. If the recovery continues, we’d anticipate bonds holding their value given the outlook for monetary policy in the coming years. Diversification isn’t the sexy cocktail party story, but it is a foundational principle of investing that has been stress tested and proven successful in achieving longer-term goals.
- Higher-yielding alternatives can be added as a complement to the core holding. Depending on the risk appetite of the client, adding higher yielding investments like preferred securities, longer dated bonds or lower credit offerings — in moderation — can potentially add to the overall yield. However, with these additions comes added risk. Many view bonds as the safety net of a portfolio, but in an attempt to find more yield they introduce more uncertainty. The decision to add these investments must fit with the client’s risk appetite. At Dana, we’ve worked with clients to help understand cash flow needs and find opportunities for higher yielding investments with longer-term capital as part of customized fixed income solution.
- Yield is only part of the story. Some of you may remember famous American radio broadcaster Paul Harvey. He had a signature saying ‘And now for the rest of the story’ where he’d provide unknown or forgotten facts about a news story. Well, yields are just part of the story in bond land. Total returns provide the ‘rest of the story,’ and at the beginning of 2020 who would have predicted that long-term bonds would have been outperforming the S&P 500 this year? Yields drop when prices rise offering price appreciation, and Dana’s actively managed fixed income portfolios can capitalize on these opportunities when presented in the marketplace.
Where do you go from here?
Don’t give up on your fixed income holdings because of the low yields they currently offer. Consult with your financial professional to make sure you own the right bonds for the today’s environment. Fixed income shouldn’t be a one size fits all solution. Dana’s fixed income solutions are built from the ground up to meet the client’s cash flow needs and fit in with their larger asset allocation puzzle. If you are troubled by the low yields, please contact us at firstname.lastname@example.org to learn more about our offerings.
Disclosure: Dana Investment Advisors welcomes any comments to their blog and is more than willing to discuss or explain any aspect of it. This blog is provided for general information only and is not intended to provide specific advice or recommendations for any individual or entity. This is not an offer, solicitation, or recommendation to purchase any security or the services of any organization or individual. The foregoing reflects the opinions of Dana Investment Advisors.