4 bond strategies to consider with market volatility on the rise  
Stephen Tuttle

Although bonds play an important role in managing portfolio risk over time, today’s environment presents some challenges to investors. Bonds didn’t provide much place to hide from recent stock market volatility. The 1st quarter of 2018 was the first quarter since 3Q 2008 where the S&P 500 and Barclays US Aggregate Bond Index had a negative total return. 

What is a bond investor to do? 

We believe today’s backdrop requires a fresh approach to bond investing. Here are 4 strategies that we think can potentially reduce equity risk while providing liquidity and income.    

  • Short-term Credit: Short-term investment grade corporate bonds currently offer comparable yields to intermediate-term government bonds with less interest-rate sensitivity.  Furthermore, their short maturity dates may offer investors the opportunity to benefit from rising rates by reinvesting the proceeds from maturing bonds into new bonds with higher coupons.
  • Floating Rate Notes (FRN): We believe FRNs offer an attractive balance between income, low volatility, and minimal downside risk. Unlike traditional bonds that pay fixed interest payments, FRNs have coupon rates that “float” with short-term rates.  Thus, when rates are rising, as they are now, investors in FRNs generally earn higher income over time and experience smaller price declines compared to fixed income securities.   
  • Treasury Inflation-Protected Securities (TIPS): Inflation expectations have risen recently, but we still believe there is value in TIPS.  The principal of TIPS increases with inflation and decreases with deflation, as measured by the Consumer Price Index.  When TIPS mature, the investor is paid the adjusted principal or original principal, whichever is greater.  At current prices, we believe TIPS provide an attractive way to hedge against unexpected rises in inflation.        
  • Emerging Market (EM) Debt: We expect EM debt to perform well during periods of gradually rising interest rates. They currently offer relatively attractive yields, which should cushion against potential price declines.  Additionally, EM economies tend to benefit when rising US yields reflect improving economic growth, as in the current rate-hike cycle. 

In the coming years, we expect a transition from low to “normal” interest rates.  History has shown that rising rates often involves some discomfort for bond holders.  However, we caution against removing traditional core bonds from portfolios altogether.  Doing so would risk severe losses in the event of a stock market slump or economic recession.  High quality bonds should continue to help portfolios in turbulent periods.  We believe that an actively-managed bond allocation, with exposure to multiple sectors and offering several sources of income are prudent strategies for diversified investors in the current environment.

The information and opinions included in this document are for background purposes only, are not intended to be full or complete, and should not be viewed as an indication of future results.

 

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