Bonds To Buy Now
Historically, bonds have offered shelter for portfolios when financial storms touch down on Wall Street. But bonds have not been a haven this year in the grip of surging inflation and fast-rising interest rates. Instead, fixed-income assets ranging from U.S. Treasuries to higher-yielding "junk bonds" have logged double-digit-percentage losses resembling declines suffered by more-volatile stocks.
bonds to buy now
But amid all the gloom in bond-land, there are rays of sunshine peeking through the clouds, says LPL's Gillum. "We think the worst is behind us," he says. The valuation and yield on all types of bonds, he says, look much better today than at the start of the year.
Just as stocks go on sale in a bear market, bonds have moved from the full-price aisle to the discount bin. That doesn't mean rates can't move even higher if inflation stays hot. But keep in mind that the forward-looking bond market has already pushed interest rates significantly higher to account for coming Fed increases. "Markets have already priced in a pretty bad scenario," says Elaine Stokes, executive vice president and portfolio manager at investment firm Loomis Sayles.
If you're eyeing even more income, high-yield bond yields recently hit 8.5%, compared with 4.35% at the end of last year; corporate bond yields hit almost 5%, versus 2.35%, according to ICE/Bank of America indexes tracked by the St. Louis Fed. The yield on the Agg is now nearing 4%, up from 1.75%. The higher yields, which provide some cushion if bond prices dip further, spell opportunity for investors whose portfolios now have low weightings in bonds.
That murky outlook is why Michael Fredericks, manager of BlackRock Multi-Asset Income fund, is not advising investors to bet on bonds "with all your chips" just yet. Stokes, of Loomis Sayles, offers this advice: "I wouldn't go all-out. I'd start tiptoeing in."
Conservative investors should consider short-term bond mutual and exchange-traded funds, which are less sensitive to future interest rate increases and now sport plump yields. "If yields of 3% to 3.5% are what you're looking for, short-term Treasuries have become a lot more attractive," says Stokes. And with shorter-term corporate bonds, "the default risk is very low," says Fredericks.
Spread your bets around, the bond pros say. And stick with high-quality and short- to intermediate-term bonds (ones that mature in three to 10 years) that offer competitive yields with less credit and interest rate risk than dicier fare, says Rob Haworth, senior investment strategist at U.S. Bank Wealth Management.
With more volatility expected, given the uncertain outlook, a good strategy is to invest in a diversified fund benchmarked to the broad Agg index, which includes investment-grade U.S. Treasuries, corporate bonds and mortgage-backed securities. "Higher-quality corporates and U.S. Treasuries can withstand economic distress," says Haworth.
The Baird Aggregate Bond (BAGSX (opens in new tab), 3.44%), a team-run fund that takes a disciplined, long-term approach that eschews big bets, is a good choice. The fund's 1.79% annualized gain over the past 10 years has outpaced 82% of its peers, according to fund tracker Morningstar. At last report, nearly 60% of the fund's assets were invested in AAA bonds, with corporates making up the biggest part (39%) of the portfolio. Passive investors might like the iShares Core U.S. Aggregate Bond ETF (AGG (opens in new tab), $101, 3.28%), which has a low expense ratio of 0.03%.
Investors willing to take on more risk to earn fatter yields should consider high-yield bonds, issued by firms with less-than-stellar financials, says BlackRock's Fredericks. If the consensus view is correct that a recession, if we get one, won't be severe, it's unlikely junk bonds will see a big increase in defaults, which takes some risk off the table. Fredericks says investors are receiving ample compensation for the risk, given that the average junk-bond yield has more than doubled since the start of the year. A solid choice is the Vanguard High-Yield Corporate (VWEHX (opens in new tab), 6.66%), a Kip 25 member as well as a top Morningstar pick for "cautious high-yield bond exposure."
High yield bonds (bonds rated below investment grade) may have speculative characteristics and present significant risks beyond those of other securities, including greater credit risk, price volatility, and limited liquidity in the secondary market. High yield bonds should comprise only a limited portion of a balanced portfolio.
In 2022, the Bloomberg Barclay's US Aggregate Bond Index, which represents the vast investible universe of US bonds, is set to do something it has never done before: lose value for the second year in a row.
However, as 2023 begins, bonds look poised to once again deliver their traditional virtues of reliable income, capital appreciation, and relatively low volatility. For the first time in decades, bond yields are high enough that income-seeking retirees can use them to help support a 4% withdrawal rate from their portfolios.
Because bond prices typically fall when interest rates rise, bond markets have long been sensitive to changes in rates by central banks. But they are also influenced by other factors such as the health of the economy and that of the companies and governments that issue bonds. Since the global financial crisis, though, the interest rate and asset purchase policies of the Fed and other central banks have become by far the most important forces acting upon the world's bond markets. In 2022, the focus of their policies shifted from supporting markets to trying to fight inflation and bond markets reacted badly.
That means angst about how interest rates might affect bond prices shouldn't obscure the fact that the return of rates to historically normal levels may present a long-awaited opportunity in bonds for those who seek income and principal protection. For years, as Managing Director of Asset Allocation Research Lisa Emsbo-Mattingly puts it, "The Fed had been financially repressing savers, especially retirees." Now, higher rates mean that retirees and savers may be able to earn attractive returns without taking much risk in 2023 and beyond.
Not only are yields up, prices of many high-quality bonds are down as a result of the 2022 selloff. That means opportunities exist for those with cash to buy relatively low-risk assets at bargain prices even as they pay yields that are higher than they have been in decades.
Emsbo-Mattingly expects the Fed to continue to raise the federal funds rate further until it has an impact on inflation. If inflation comes down closer to the 2.5% range where the Fed wants and expects it in 2023, real rates, which are bond yields minus the rate of inflation, could rise further into positive territory. This would help high-quality bonds to once again be meaningful contributors for many retirees who are looking to supplement Social Security, pensions, and other sources of income.
The opportunities provided by higher rates could be short-lived. Getting inflation under control is the focus of Fed policy in the months ahead, but the central bank also wants to make sure it has room to cut rates if the economy goes into recession, potentially in 2023. Rate cuts are the most powerful tools the Fed has to stimulate economic growth and the central bank wants to be able to make impactful cuts when necessary. That could mean that the opportunity to add low-risk, high-yielding bonds to your income strategy may not be there if you wait too long.
If you're considering individual bonds, you should know that the bond market is large and diverse and getting the best prices can be tricky. Fidelity can help by offering a wide range of ways to research bonds as well as professional help to construct a portfolio that reflects your needs, your tolerance for risk, and your time horizons.
In general, the bond market is volatile, and fixed income securities carry interest rate risk. (As interest rates rise, bond prices usually fall, and vice versa. This effect is usually more pronounced for longer-term securities.) Fixed income securities also carry inflation risk, liquidity risk, call risk, and credit and default risks for both issuers and counterparties. Unlike individual bonds, most bond funds do not have a maturity date, so holding them until maturity to avoid losses caused by price volatility is not possible. Any fixed income security sold or redeemed prior to maturity may be subject to loss.
Lower yields - Treasury securities typically pay less interest than other securities in exchange for lower default or credit risk.Interest rate risk - Treasuries are susceptible to fluctuations in interest rates, with the degree of volatility increasing with the amount of time until maturity. As rates rise, prices will typically decline.Call risk - Some Treasury securities carry call provisions that allow the bonds to be retired prior to stated maturity. This typically occurs when rates fall.Inflation risk - With relatively low yields, income produced by Treasuries may be lower than the rate of inflation. This does not apply to TIPS, which are inflation protected.Credit or default risk - Investors need to be aware that all bonds have the risk of default. Investors should monitor current events, as well as the ratio of national debt to gross domestic product, Treasury yields, credit ratings, and the weaknesses of the dollar for signs that default risk may be rising.
It has been a long time coming, but 2023 looks to be the year that bonds will be back in fashion with investors. After years of low yields followed by a brutal drop in prices during 2022, returns in the fixed income markets appear poised to rebound. It's likely to be a bumpy ride due to the cross currents created by global central banks' tightening policies, a volatile global economy, and ongoing political uncertainty here and abroad. Despite these challenges, we see opportunities in 2023 for the bond market to provide investors with attractive yields at lower risk than we've seen for several years. 041b061a72