Buying and holding bonds in the current environment might
make you ill. If you hold a Treasury
Bond for 10 years you receive roughly 2% on that money annually for the next 10
years. That’s in nominal terms
too. If inflation averages a little more
than 2% that you essentially get 0%.
Higher quality corporate bonds aren’t much better.
Note: Left graph is
based on 10-year Treasury bond coupled with inflation expectations. Right graph is AA Corporate effective yields.
To summarize the graphs – buying and holding a Treasury or
high quality corporate bond for 10 years is the investing version of Chinese
water torture. So why invest in bonds
at all?
- They still will likely provide the best hedge against a declining equity market. From November 07 to March 09 S&P 500 declined 44% with the Aggregate Bond Index was up 7%.
- Smart money is on Fed staying loose and keeping interest rates low for some time. Even if they taper bond purchases later this year or early next year.
- Demographics and risk aversion provide a market for higher quality bonds.
- Yields can stay low for a long time. Ask Japan.
- Since 1976 the Aggregate Bond Index max loss over a 12 month period has been 9%. Not what I would call a catastrophic loss so your principal probably won’t be decimated.
- The world bond market is $90 trillion (compared to equity market size of $40 trillion), so there are a lot of places to seek out return (i.e. there are more than just Treasuries and Corporates out there).
- There isn’t a bubble, at least anecdotally. How many investors you know brag about their bond portfolio over the past few years and compare that to their real estate portfolio in 2007 or their tech stock portfolio in 1999.
- Check this out:
That shows the 10 Year bond going from 2% to about 1.60% in a little less than 2 months. It also shows the long bond ETF going up in value. Point being, bond trades can capitalize on these quick moves in yield.
I take all of the above and come up with the following bond
investment cocktail.
- While the risk of buying and holding is probably low, the upside is muted when it comes to quality bonds.
- Still given the depth of the bond market and short-term moves in yields, returns can be had.
- Thus, move away from more passive buy and hold bond investing to quality managers who have the leeway and skill to navigate the fixed income space.
Past performance is no guarantee of future results. Diversification does not guarantee a profit or protect against a loss. International investing involves special risks, including, but not limited to, the possibility of substantial volatility due to currency fluctuation and political uncertainties. The views and opinions expressed herein are those of the author(s) noted and may or may not represent the views of Capital Analysts, Inc. or Lincoln Investment.
