By Elizabeth O'Brien
Bonds have disappointed in recent years, burning investors with losses and leading some to wonder if they should bother with them at all. Short answer: Yes, but it pays to be strategic.
"We've been getting questions about allocations to fixed income because it provided limited returns over the past three years," says Kurt Spieler, chief investment officer of wealth management at First National Bank of Omaha. "Anytime that happens, people say, 'Why do we have it?' "
Amplifying that concern is the fact that cash remains an attractive alternative. Why take a chance of bond losses when you can get risk-free yields of 5% in money-market funds?
The reason, says Dustin Thackeray, chief investment officer at Crewe Advisors in Salt Lake City, is that you can't lock in those cash yields. Once the Federal Reserve begins to cut interest rates, cash and bond yields will fall, and bond prices, which move inversely to yields, will rise.
Bonds will also reward patience, experts say. The market is emerging from a painful transition from ultralow interest rates to the moderate-rate environment we have today. Many pros predicted that bonds would break out of their funk this year, but the "higher for longer" rate scenario has hurt them in the short term.
On Wednesday, the Federal Reserve left rates unchanged and cited a "lack of further progress" on the committee's 2% inflation target. Bond yields fell, with the 10-year Treasury declining 0.09 percentage point to 4.59%. Still, it is up from 3.95% at the end of 2023. That has pushed the benchmark U.S. bond index down about 3% this year.
While it takes a bit more legwork, it's an excellent time to lock in yields in individual bonds. If you hold a Treasury note or other highly rated bond to maturity, you needn't concern yourself with price fluctuations, since you'll get your principal back when the bond matures. Kathleen Grace, CEO of Fiduciary Family Office in Boca Raton, Fla., has been buying municipal bonds for clients with yields of about 4.5% to 5%. "It has been a long time since we've seen rates this high," she says.
Bond mutual funds and exchange-traded funds may be more volatile, but they offer more liquidity and a much more affordable entry point for investors than individual bonds.
Moderating inflation could also help bonds provide some stability and income when stocks falter. Fixed income has historically provided that ballast, rising as stocks fall or declining less precipitously. That relationship was tested in 2022, when U.S. bonds tanked 13% and stocks dropped 19%. The disruption was caused by high inflation and the Fed's rapid-fire rate hikes; as those forces recede, bonds should once again provide a cushion in portfolios.
With yields now higher and the big inflation spike over, some experts like the long-term outlook. "If you're able to look out three to five years, there's a good total return opportunity," says Adam Abbas, portfolio manager and head of fixed income at fund manager Harris Associates.
Abbas and other bond pros see opportunity in intermediate durations of about five to seven years. The Bloomberg Intermediate Government/Credit Index yields 4.8%, providing enough cushion for a slightly positive total return even if rates rise by a percentage point, Spieler says. If rates fall, the more likely scenario, then investors will get a bigger total return. The iShares Intermediate Government/Credit Bond ETF (ticker: GVI) tracks that index and yields 4.8%.
Investors willing to venture beyond the U.S. can lock in higher yields -- albeit with more volatility. The iShares J.P. Morgan USD Emerging Markets Bond ETF $(EMB.AU)$, for instance, yields 7%. But it hinges on factors like currency fluctuations and economic conditions in countries such as Turkey, Saudi Arabia, and Brazil; the extra yield it offers -- about two percentage points more than short-term U.S. Treasuries -- may not compensate for steep drops in price.
Emerging market bonds do have appeal: Mexico's sovereign bonds yield more than 10%, says Kevin Ritter, interim head of emerging markets at Western Asset. While the U.S. bond market is closely tethered to the Fed, other countries in different stages of economic cycles "lend themselves to opportunities," he says.
Still, it's best to stick largely with Treasuries and other high-grade U.S. bonds, which should get back to their traditional role: providing income and stability when you really need it.
Write to Elizabeth O'Brien at elizabeth.obrien@barrons.com
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(END) Dow Jones Newswires
May 03, 2024 21:31 ET (01:31 GMT)
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