The yield on unwanted bonds may seem attractive, but investors need to be careful with them, as the possibility of a recession is looming.
Illustration of Barron’s scepter; Dreamstime (1)
Text size
Investors have been hit from all sides this year, with stocks, bonds and cryptocurrencies reporting huge losses. For the first time in years, however, rising bond yields have brought a good position for retirees and other income-seeking investors.
Although bond prices may continue to fall until The Federal Reserve is aggressively raising interest rates to beat inflationas profitability and prices move in the opposite direction, higher insured incomes could now pay off in the long run. The Bloomberg Barclays US Aggregate Bond Index fell 11.5 percent for the year, but the yields on many major bond funds rose to 3.3 percent or even higher.
These yields provide some cushion against further price losses, they said Christine Benz, Director of Personal Finance and Retirement Planning at Morningstar. Although they may not fully offset losses if bond prices fall further, they will do a better job than before to maintain the overall return on retirees. (Individual investors experience mostly losses in bond funds. If you buy an individual bond and hold it to maturity, you will not see any fluctuations in prices that occur at changing interest rates.)
Moreover, with higher quality bonds offering better yields than they have had for years, investors should not venture into riskier corners of the market in search of income. “Higher incomes come to you with safer bonds,” Benz said.
So what should retirees do right now? For starters, no matter how painful the first half of the year was, now is not the time to give up your bonds.
“Now that rates are reset, there is an opportunity,” said Brad Rutan, managing director and fixed income specialist for MFS Investment Management. “That’s what everyone was waiting for.”
The reference 10-year treasury bond yielded 3.23%, compared to 1.63% at the beginning of the year. The yield on BBB-rated corporate bonds with a 7.4-year duration is around 5.2%, well above the 2.55% level where they started at the beginning of the year and roughly where they were during the depth of the Covid crisis. -19, said Adam Abbas, co-head of the fixed-income division at Harris Associates, which manages Oakmark Funds. This is the lowest level of investment grade bonds, but their average default rate has been a negligible 0.06% in the last two decades, Abbas said.
The spread of these bonds on government bonds – a measure of how much investors are rewarded for taking additional risk over risk-free government bonds – has widened to the 60-75th percentile, depending on the sector and maturity; at the beginning of the year, spreads were about 40% lower, and their recent widening means that investors are being more rewarded for taking the risk that a recession could increase corporate defaults. (A spread in the 100th percentile would reflect many bearish expectations.)
Benz recommends a package approach to fixed income, with money for expenses to be made in the next two or three years in cash, money for intermediate expenses in short-term bond funds and money for long-term expenses (for six years to 10) in the index fund on a wide market such as
Vanguard Total Market Bond ETF (BND).
There are two corners of the bond market where yields or the outlook for inflation protection may look tempting now, but they deserve more attention, market observers say.
The first securities, protected from inflation, reflect expectations of future inflation and are not attractive at the moment if you think the Federal Reserve will be able to control inflation, Abbas said. “The time to be at TIPS is probably in the past,” he said. However, if you think that prices may continue to rise higher than expected, then the distribution of TIPS makes more sense.
However, with the exception of shocks that could come from macroeconomic data or geopolitical conflicts, Abbas said the bond market is less likely to be rocked than it was when Inflation data were higher than expected in May. Inflation expectations have stabilized, in part because Fed officials have made it clear they will do whatever it takes to cut inflation, and raised their short-term interest rate by 0.75 percentage points last week, leaving room for future sharp rises.
The other area to look out for: high-yield bonds. The so-called junk bonds have had a difficult year with
SPDR high yield bond portfolio
The ETF (SPHY) fell 13% year-over-year as yields rose. This drop in prices has made unwanted bonds more attractive, Abbas said, although bonds with a lower investment rating are still a better deal at the moment. Timothy Chubb, chief investment officer at Girard, a wealth consulting firm in King of Prussia, Pennsylvania, said high-yield spreads have not widened enough to compensate investors for the chances of a slight recession or further interest rate hikes. the central bank.
No matter how high the return on non-investment grade debt is, investors need to remember that in an economic downturn, unwanted bonds tend to present themselves more as stocks than other bonds, Benz said. If investors want to dip their fingers into the category, she added, they could do so as part of a multisectoral bond fund that has the flexibility to own some high-yield holdings, such as
Loomis Sayles Core Plus Bond Fund
(NEFRX).
While bonds fell along with stocks this year and did not provide the ballast they normally do in portfolios, rising incomes mean that fixed-income investors can calm down if the economy falls into recession. “If things get worse,” Abbas said, “the ballast will come back.”
Write to Elizabeth O’Brien at elizabeth.obrien@barrons.com
