Anmol Sinha, Fixed Income Strategist: We’ve been having a lot of conversations recently with clients about the role of core bonds in their portfolios today, and why it may be more important than it has been in the last several years.
So investors should be thinking about core bonds today really because of the macro backdrop.
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The environment that we are in today is one where we are into the later stages of this expansion. We’re certainly nearer the end than we are the beginning. Volatility is rising. And volatility is rising in asset classes where valuations are extended.
So for the first time in a long time, investors have to really think about the need for diversification in their portfolios. And that’s why we think today is really a good time to be thinking about core bond allocations.
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The defining feature of core bonds tends to be that they have a lot of interest rate exposure.
And therefore core bonds tend to be affected when rates rise. Prices fall when rates are rising. So that’s certainly a big concern.
But there may be two reasons why clients should worry less about that.
The first is that we don’t think rates have a lot more to move higher from here. We tend to think rates are generally range-bound, given the fact that they tend to be anchored by growth. Underlying trend growth in economies like the US have not really changed. They’re still fairly low.
So as rates have risen, now they’re kind of in line with where they should be given overall growth environments. If rates don’t have a lot more to move from here, is really my second point.
Which is that, at these yield levels, the higher yield levels, core bonds are more attractive from a return perspective.
The reason is that when you have high yields, that means that your forward-looking return expectation is high.
In fact, core bonds today have a much higher return expectation going forward than they did three years ago. It’s actually hard to stop and think about any other asset class that gives you that kind of profile. And it happens to be the asset class that gives you better diversification in times of market stress.
So we think that core bonds will actually play a very important role in investor portfolios going forward. And that is really one of being an anchor.
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So in a world forward where there’s likely to be more volatility, more uncertainty, that need for diversification is really magnified. And so we think investors really need to think about having a true core allocation.
So again, if you think about that backdrop, where we’re in the later stage of the expansion, where volatility is rising, where valuations are stretched, that backdrop really warrants core bonds. The fact that we’re through a lot of this rate move and now perhaps there’s less pain to be had going forward because interest rates are likely to be range-bound.
You don’t have that headwind that you had with interest rates. And in fact, the value you can earn from core bonds, because yields are higher is much better than it was a few years ago. Meaning the value proposition you get, in a time when you need the diversification, is really key.
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All investments contain risk and may lose value. Investing in the bond market is subject to risks, including market, interest rate, issuer, credit, inflation risk, and liquidity risk. The value of most bonds and bond strategies are impacted by changes in interest rates. Bonds and bond strategies with longer durations tend to be more sensitive and volatile than those with shorter durations; bond prices generally fall as interest rates rise, and the current low interest rate environment increases this risk. Current reductions in bond counterparty capacity may contribute to decreased market liquidity and increased price volatility. Bond investments may be worth more or less than the original cost when redeemed. Diversification does not ensure against loss.
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