Partner Insight: For many investors, bonds represent only a 'safe haven' or 'low yielding' type of investment. But not all bonds represent safety, and there are many types of bonds that are able to provide a steady or high yield in all sorts of interest rate environments as well.
There is a lot of talk amongst investors about the ‘death' of the 35-year old bond bull market as global interest rates start to rise and central banks begin reversing their quantitative easing programmes. Bond yields are quite low as a result and investors are having to search harder for income.
Yet the bond market is one of the largest securities market in the world and throughout history investors have bought bonds for a number of reasons from capital preservation, income, and diversification too. They can even be used as a potential hedge against economic weakness or deflation too, as when the economy slows down and inflation falls bonds become more attractive as it means bond holders can buy more goods and services with the same bond income.
Therefore, even in a rising rate environment, it is important to remember that not all bonds are impacted equally and the market today does not imply negative total returns for many bonds. The credit and emerging market debt sectors for example may perform better or worse than government bonds during a rising rate period. Other assets such as floating rate notes and inflation-linked bonds can also actually help protect investors from rising inflation.
Arguably, the higher interest rates we are seeing in economies like the US and the UK are improving the ability of bonds to provide diversification, particularly in a broader portfolio via better performance in ‘risk-off' events. Unsurprisingly, the bonds that underperform in market environments like we see today tend to be the most equity-like in terms of risk, such as subordinated financial debt, credit default swap indices and in some cases, high-yield credit.
In today's market environment, and with credit spreads tightening amid rising rates, many investors believe the focus should be on shorter duration credit assets, in order to benefit from tightening spreads but defend investors' cash from those rising yields. Indeed, duration is paramount today and something all investors should be aware of, especially if rates rise, and an investor has very long duration, it could have a big impact on the performance of the fixed income fund.
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