One of the big questions in the fixed income markets is if rates rise, do bonds still make sense? The media is intimating that bonds are due to fall in value as rates increase. It is true that the value or price of a bond is inversely related to interest rates, but this is a myopic point of view of the benefits of bonds.

First, focusing solely on the price changes ignores the yield or the income component that bonds generate. Total return of any investment is ultimately comprised of two components, income and appreciation. Erroneous conclusions can result if the improper context of both aspects is not considered.

Secondarily, investment grade and government bonds tend to be the primary diversifier (primary shock absorber) to stock market shocks when they occur. Even in the currently low yielding environment, market volatility often causes investors to seek cover by moving dollars to more secure assets. This generally means higher credit quality bonds and/or cash vehicles.

Undoubtedly, lower yields offer less stock market “cushion.” This should make intuitive sense as less cash generation means more reliance on an investment’s appreciation potential. But in the context of all available markets, declines and shocks cause investors to look to contractual obligations, increasing their demand and driving up prices. Hence, this is why bonds tend to be the best stock market shock absorbers. As of March 31st, bonds were providing low correlations to the stock market, meaning even with low yields, there are diversification benefits to be had.

Lastly, investment grade and government bonds have exhibited far less volatility than that stock market, portfolio design should consider asset class statistics. The historical record, as well as anecdotal experience, is clear… stocks provide higher returns over the long-term, but that comes at the risk of much higher short-term volatility. Bonds are almost the opposite. The relative stability of bonds and contractual income generation offers benefits not afforded by stocks and positioned within a portfolio as the more secure assets. Think of a skyscraper without a proper foundation, an earthquake can cause a collapse.

Is there still a place for bonds in a portfolio? The answer is absolutely yes! The media can often shortcut details for expediency and viewership retention. As such, we find it our responsibility to broaden the dialog with the proper context. Happy Mother’s Day to those who have played such an important part of our lives. Have a wonderful weekend.

 

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