Bond market insights at a glance
August 6, 2013
What should I do about the low-interest rate environment? It’s the number one question that clients are asking and is unlikely to go away for as long as uncertainty surrounding the low interest-rate environment persists. To help advisors, Vanguard has compiled a series of fixed income briefs that highlight considerations for some of the most pressing issues of the day. Included in the series are:
- Investment-grade bonds are among the best diversifiers of equity risk In the current low-yield environment, investors may be reaching for yield without understanding the concentration risk of this strategy. The chart illustrates the correlation of higher-yielding assets to stocks during periods of extreme market stress. When stocks suffer losses, Treasuries have consistently provided a buffer against substantial losses.
- Bonds have never reached the depths of a bear market for stocks Headlines about an impending bond bear market have renewed memories of the severe losses sustained during the global financial crisis. However a comparison of the worst 12-month returns between stocks and bonds shows that a bear market in bonds is nowhere near as bad as a bear market in stocks.
- Setting realistic expectations for portfolio returns Clients with lofty expectations for portfolio returns may be in need of a reality check. Vanguard’s projections of balanced portfolio returns over the next ten years are generally below historical averages. Clients will need to accept the reality of lower returns or be prepared to take on additional volatility.
- Shortening maturities may help protect principal but could lower income Clients may be shortening duration as a strategy to hedge against interest rate risk. There are several tradeoffs and considerations to this strategy, such as greater than expected losses should short-term rates rise faster than long-term rates. Clients also risk missing out on higher yields should rates stay low.
- Reaching for yield can also increase volatility An important question that advisors should ask clients who are reaching for yield is: Will you be able to stomach a dramatic downturn in the markets? Higher-yield assets will not provide the same buffer from losses as investment-grade bonds such as Treasuries.
Advisors may use these briefs to speak with clients about various strategies and their considerations in the current low-yield environment.
- All investing is subject to risk, including the possible loss of principal.
- Bond funds are subject to the risk that an issuer will fail to make payments on time, and that bond prices will decline because of rising interest rates or negative perceptions of an issuer's ability to make payments.
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