Historic low interest rates
No matter how you twist it, bond yields are historically low. Many investors therefore wonder why they should hold bonds at all. From our point of view, the main purpose of bonds is to dampen the volatility of the portfolio. Accordingly, they are suitable as an admixture for investors who, for example, want to make ongoing withdrawals from their portfolio and at the same time consider a smaller fluctuation range to be optimal.
Ten-year US government bonds are currently trading at 0.93 percent, Bunds with the same maturity at -0.57 percent. Negative! Corporate bond yields have also followed a long-term downward trend, most recently US corporate bonds with investment grade ratings below two percent for the first time. In the economic expansion phase from 2009 to 2020, average values of 2.4 percent for US government bonds and 3.5 percent for US corporate bonds were achieved. In Europe, negative interest rates, especially on government bonds, have long been a familiar sight.
Bonds serve a purpose anyway
However, these negative records do not mean that bonds have fundamentally lost their raison d’etre. In the short term, they tend to fluctuate less than stocks, so investors should continue to weigh this carefully. If your long-term investment goals are to generate relatively high cash flows from your portfolio, a mix of stocks and bonds can be very beneficial. In the end, the total return view, the combination of price movements and income, is the decisive criterion.
Dividends are of course an excellent “substitute for interest”, but they fluctuate. In the short term, the variance in stock returns is also very high – which is why regular withdrawals could lead to an unwanted burden on the portfolio if high withdrawals meet periods with below-average returns. The lower standard deviation of bond yields has a helpful stabilizing effect.
Record-low interest rates are repeatedly interpreted as an anomaly that must inevitably be resolved. This movement could be helped by allowing the economy to move past the COVID-19 headwinds. And since bond prices develop inversely to interest rates, many experts believe that caution is advisable here. These considerations are correct to some extent, but careful positioning in the bond space helps diversify this risk. Bonds with shorter maturities are less susceptible to interest rate hikes, and those who expect interest rates to rise can dampen the impact on total return by reducing the duration in the bond portfolio. However, interest rates are related to inflation expectations, so one should primarily investigate the question of what can cause rising inflation. A slight rise in inflation can currently be observed, although this is also due to a base effect. The speed of circulation of money remains low and the central banks’ purchase programs will continue to have a disinflationary effect due to the flattening of the yield curve.
The same applies to bonds as to stocks: It depends on the degree of admixture in the portfolio. Then bonds are a good help for certain investment goals – this fact does not change even with record low interest rates.
You can request the current capital market outlook from Grüner Fisher Investments free of charge at www.gruener-fisher.de.
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