The impact of rampant inflation has been felt across asset classes, presenting a material challenge for investors. But its legacy is a compelling opportunity.
Ready to compete
While government bond yields have proved to be rather volatile as policy rate expectations change dramatically, they are significantly above those seen in most of the last ten years. As a result, bonds can finally compete with equities as a yield-generating asset class.
… traditional income-generating assets are back in play.
Investment grade credit in the UK and US offer well over 5% yields.1 High yield markets are giving investors more than 7%.2 For retail investors, municipal bonds also look attractive at close to 6% yields on a taxable-equivalent basis.3 Clearly, traditional income-generating assets are back in play.
Lower risk?
While other assets offer both income and the scope for capital gains, bonds can now take their rightful places in diversified portfolios. We believe they currently offer a lower-risk source of income.
In an uncertain world, we believe the case for holding bonds in a portfolio is stronger than it has been for some time.
That’s not to say that bonds are risk-free. However, the yields available provide a decent amount of comfort, as well as the potential for inflation-beating returns. In an uncertain world, we believe the case for holding bonds in a portfolio is stronger than it has been for some time.
Something for everyone
The enormous bond universe offers something for everyone. Each type of bond merits consideration for a place in a diversified portfolio.
As mentioned, high yield corporate bonds can offer yields approaching 8%.2 While that market comes with risks if the global economy slows, it also offers scope for capital appreciation if the macro situation continues to improve.
Building stability
At the other end of the spectrum, government bonds can, once again, offer potential stability in a diversified portfolio of risky assets. The risk to this asset class primarily comes from the best possible economic outcome, where growth picks up and inflation comes back. But this situation is likely to help those riskier asset classes.
Investment grade credit should offer a little bit of both. Investment grade yield is made up of a combination of underlying government bond yields and credit premiums, also known as spreads. A negative economic outcome may cause those spreads to rise but would force yields lower. While a positive economic outcome may push up yields but keeps a lid on those spreads.
Final thoughts
Bonds of all shapes and sizes are returning to popularity. Yields are competitive and relatively attractive; markets are liquid and accessible, and bond volatility is likely to be materially lower than equity volatility.
1 Bloomberg US Credit Total Return Value Unhedged USD, April 2024.
2 Bloomberg U.S. Corporate High Yield Bond Index, April 2024.
3 Bloomberg Municipal Bond Index, May 2024.
Important information
Fixed income securities are subject to certain risks including, but not limited to: interest rate (changes in interest rates may cause a decline in the market value of an investment), credit (changes in the financial condition of the issuer, borrower, counterparty, or underlying collateral), prepayment (debt issuers may repay or refinance their loans or obligations earlier than anticipated), call (some bonds allow the issuer to call a bond for redemption before it matures), and extension (principal repayments may not occur as quickly as anticipated, causing the expected maturity of a security to increase).
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