How have rising interest rates affected forward-looking fixed income return expectations?
Recent results have been challenging for fixed income investors, as the rising yield environment have weighed on fixed income portfolio returns this year, albeit to a more modest degree. However, investors should look beyond recent returns when considering the role of any investment in a portfolio. That’s certainly the case today for bonds.
First, it’s important to remember that long-term bond returns are overwhelmingly derived from coupon payments, with price appreciation playing a negligible role. The opposite has been true in recent years as yields were quite low and surging inflation created volatility across both equity and fixed income markets. Those factors created significant short-term headwinds to bond returns, but don’t reflect current conditions or the forward outlook. Regardless of the rate environment, investors who hold bonds to maturity benefit from regular coupon payments and a return of their invested principal at maturity, absent a default. That hasn’t changed.
Secondly, the outlook for fixed income going forward is much stronger today than it has been in some time. As shown above, the yield on 10-year Treasury bond at a given point in time has historically been a very good indicator of the total return on high-quality bonds over the subsequent decade, as measured by the Bloomberg U.S. Aggregate Bond Index. With yields recently near 5%, the prospective performance for fixed income is at its highest point since before the global financial crisis 15 years ago.
Looking ahead, bonds should be well positioned to contribute more significantly to the return provided by a diversified portfolio, despite — and a direct result of — the significant upward push in interest rates in the past few years.
Past performance does not guarantee future results. All investments include risk and have the potential for loss as well as gain.
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