For many investors, bonds serve as an important source of income and portfolio diversifier, providing a ballast to their portfolio when equities decline. In October, the volatility that emerged in equity markets was caused (at least in part) by rising interest rates, creating a brief period of modestly negative returns in bonds even as stock prices were falling. That changed in recent days, as equity market volatility drove a brief flight to quality and high-quality bonds proved beneficial.
Today, there is little that looks “cheap” across the capital markets, and bonds are no exception. Consequently, investors may feel stuck between a rock and a hard place in their search for income. Investing in long-term bonds certainly can enhance a portfolio’s yield, but also exposes the investor to greater interest-rate risk, which is particularly distasteful in a rising rate environment. Investing in credit-oriented sectors can also enhance yield, but exposure to credit risk when the economy is decelerating and conditions are volatile can create a bumpy ride, while potentially reducing the diversification benefit of bonds at a time when it would be most beneficial.
Against that backdrop, high-quality municipal bonds remain an attractive option for many taxable investors. Generally, municipals are less sensitive than taxable bonds to interest rate fluctuations. In addition, current tax-adjusted yields remain attractive relative to high-quality taxable bonds, further enhancing their attractiveness in the current environment.
Further, we believe the environment is conducive to active bond managers who are not beholden to closely mirroring a broad market benchmark. The flexibility to manage portfolio positioning and duration, to avoid those sectors and securities that don’t present an attractive risk/return profile, to identify interesting opportunities, and make portfolio adjustments over the course of time are among the tools that managers can use to add value and navigate a challenging fixed-income environment.
Investors must balance a variety of considerations in structuring their bond portfolio. For most investors, bonds represent the portfolio “safety net”. It may be tempting to reach for yield, but the old maxim holds true in this context: don’t risk a lot for a little.
The bottom line:
Investing with quality active managers and tilting portfolios toward municipals remain effective ways to navigate the current bond market environment.
Past performance does not guarantee future results. All investments include risk and have the potential for loss as well as gain.
Data sources for peer group comparisons, returns, and standard statistical data are provided by the sources referenced and are based on data obtained from recognized statistical services or other sources believed to be reliable. However, some or all of the information has not been verified prior to the analysis, and we do not make any representations as to its accuracy or completeness. Any analysis nonfactual in nature constitutes only current opinions, which are subject to change. Benchmarks or indices are included for information purposes only to reflect the current market environment; no index is a directly tradable investment. There may be instances when consultant opinions regarding any fundamental or quantitative analysis may not agree.
Plante Moran Financial Advisors (PMFA) publishes this update to convey general information about market conditions and not for the purpose of providing investment advice. Investment in any of the companies or sectors mentioned herein may not be appropriate for you. You should consult a representative from PMFA for investment advice regarding your own situation.