What role do bonds play in your portfolio?

It is certainly a challenging time in many parts of the investment world. Volatility is at very high levels in the equity markets. Interest rates are at historic lows and credit concerns continue to be a factor in the bond markets. We have seen a multi-decade decline in interest rates and it is hard to imagine them going much lower. Governments here and abroad are struggling with debt issues. Where does this leave a bond investor and is this an asset class that you simply should ignore going forward?

Traditionally, bonds have played the role of an asset diversifier in portfolios, providing returns that are uncorrelated with the stock market. This has certainly been the case in the recent past as bonds have performed very well as interest rates declined. Bonds also are often in a portfolio to generate income, and provide cash flow for those who need to use the income from their portfolio for living expenses. While neither of these roles will likely go away completely, there may be other reasons to include bonds in your portfolio.

Looking at bonds and more specifically certain categories of bonds on a total return basis may make sense going forward. When you look at the historic returns of various fixed income indices over the past 10 years, you will see a variability in returns that is similar to equities. There may be “tactical” reasons to have exposure to certain elements of the bond market over time.

 As you consider specific types of bonds in the current environment, there may be opportunities to uncover value. For instance, while municipalities and states certainly have ongoing financial concerns, the yields on municipal bonds on an after tax basis are equal to or above Treasury securities. If a manager understands the sources of payment on these bonds, they may not have the risk that seems to be painted on the entire asset class. Foreign bonds are another example of an area where opportunities may exist. Other countries where debt to GDP ratios are not as high as the US or other Western European countries may present opportunities.

The bond market is very large, many times larger and more complex than the stock market. We look to individual bond managers or mutual funds that invest in bonds to help our clients manage their bond allocation. While bond mutual funds have their own risks when we do ultimately see a rising rate environment, we find that this might be the best way to access certain classes of bonds or to get bond exposure for smaller accounts. This part of your investment strategy should always be grounded with a clear vision of your risk tolerance, return requirements, and cash flow needs.

Let us know if we can help you think about the role that bonds play in your portfolio.

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