Bonds in portfolio. A subtle hero, even now.
By Thomas J Aldrich III
Engines and Brakes
When it comes to sports cars, everyone always wants to talk about the engine. It's the most interesting part of every sports car, "How much Horsepower does it have?", "Is it a V6 or V8 engine?", "What is it's 0-60 time?". Within every sports car, there is a subtle part to the vehicle that doesn't get talked about. That is the brakes.
Investment portfolio's are often treated the same way. Everyone wants to talk about their biotechnology stock that grew 40% in the last 3 months or their semiconductor stock that is experimenting in artificial intelligence and has the potential to completely change the way our computers operate. It's rare that an investor will brag about their 10 Year Treasury Bond yielding 2% which helps to provide stability and income to what could otherwise be a volatile portfolio.
Car enthusiasts don't brag about their brakes. Investors don't brag about their bonds. While it seems ridiculous to abandon brakes in a car, some investment professionals and news outlets are calling for an abandonment of bonds in a balanced portfolio.
The Importance of Bonds
Within a balanced portfolio with a sleeve dedicated to bonds, you may be presented with different types of bonds. US Treasury bonds which are issued by the US Governments, Corporate Bonds issued by private or public companies, International Bonds which may be purchased with hedged or unhedged currencies, mortgage backed securities (the list goes on). Most investors will tend to use bonds as a way to diversify their portfolio away from stocks. One of the most important parts to bonds is their ability to provide lower correlation to the US Stock Market. Specifically ,when we compare the performance of the 10 Year US Treasury to the US Stock Market Index, we find that these assets have a correlation of 0.04. (data provided by Portfolio Visualizer between Jan 1 1972 and May 1 2022). This means that the 10 year Treasury will track the price of the US Stock Market Index 4% of the time.
This is an important feature because the 10 Year US Treasury will provide investors an area of their portfolio to "bank profits" during growth. If that isn't good enough, you also can collect a coupon on your bond, while you continue to hold it. Income and stability. These are why most investors choose to own bonds. But what happens when bonds don't hold up? Like this year?
Worst ever start to a year for bonds
This year, much of the volatility in bonds has originated from the Federal Reserves position to raise the Fed Funds rate to try and curb inflation. As of April 1st, the bond market is on pace for it's worst start to the year ever. As of April 1st, the Bloomberg US Agg Bond Index is down 9.5%. While this is historically bad in terms of bond market corrections, we have seen volatility before. The shocker: Sometimes we can see exceptional returns from our bonds, even after such volatility. Please refer to a chart provided to us from our friends at BlackRock Investment Management.
Respect your Bonds
While much of this volatility can be derived from expectations of the Federal Reserve increasing the fed funds rate, we always need to be humble enough to know that we can't predict the future. What I implore you to do is, understand your portfolio. Acknowledge the differences between your engine and your brakes and work with a financial advisor to build the perfect balance for you. Don't lose hope in your brakes, even now. They might come in handy some day.
Disclaimer:
Source: Morningstar as of 4/30/22. U.S. bonds represented by the IA SBBI US Gov IT Index from 1/1/26 to 1/3/89 and the Bloomberg U.S. Agg Bond TR Index from 1/3/89 to 4/30/22. Past performance does not guarantee or indicate future results. Index
performance is for illustrative purposes only. You cannot invest directly in the index.
The following information is meant for information purposes early and should not be considered investment advice. For investment advice please contact a financial advisor.
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