Don’t laugh, but there’s a hint of FOMO in bonds
Is there a FOMO mindset, or fear of missing out, developing in the US bond market? Disbelieving investors might hear this and ask sarcastically, “Afraid of missing out on what?” Lose more money on falling bond prices while collecting insufficient returns during a period of runaway inflation? »
Fixed income is generally considered safe and boring, but overall this asset class has been anything but in 2022. According to Sara Devereux, principal and global head of fixed income at Vanguard, the first quarter marked the bond market’s worst performance in more than 40 years. She said this has prompted some of her firm’s clients to question the role of bonds in 60/40 portfolios, or whether they should shorten duration and seek a credit risk premium or private assets.
Speaking to an audience of financial advisors and others in a presentation this week at the Exchange ETF conference in Miami Beach, Florida, she speculated that advisors are also hearing these questions from their clients. But she cautioned advisers against throwing in the towel and abandoning traditional bonds. Despite the apparent gloom, she says, there are glimmers of optimism.
“More recently, I’ve heard from others who wanted to take the other side because yields have moved a lot and valuations look attractive,” Devereux said. “There are few signs that FOMO is creeping into the bond market.”
She noted that the top three concerns for fixed-income investors are inflation, the impact of the Federal Reserve’s plan to systematically raise interest rates to keep inflation under control, and low yield expectations. .
Inflation hit a four-decade high of 8.5% in March. “We believe inflation and the central bank’s response to it will remain a key risk in markets this year and next,” Devereux said.
She noted that markets have already priced in 11 Fed rate hikes, but the good news is that higher rates mean higher future returns.
“Our return outlook for the next decade will be above a range of 2% to 3% per year,” Devereux said. “Parts of the bond market are becoming attractive again for the first time in a long time.”
Nevertheless, she noted, the bond market faces many unknowns. In an attempt to alleviate this uncertainty, she highlighted four basic general strategies for long-term success, regardless of the environment. They are the following:
Devereux stressed that clients should hold bonds to diversify equity risk, even when rates rise. “Diversification is the only free lunch in investing,” she offered.
She presented a chart showing the median returns of various asset classes during the worst decile of monthly U.S. stock performance over the 20-year period ending February 28, 2022. The result was that six out of eight categories of Bonds featured (excluding emerging market government bonds and US high yield bonds) were in the green while all five equity classes, plus commodities, were in the red.
“Our model shows that when stocks fall, fixed income holds up,” Devereux said. “While there may be periods of volatility and dislocation in the short term, over the long term bonds are an effective diversifier. You cannot expect this relationship to hold every day, but rather on average over your investment horizon.
She recommends advisors stay disciplined and focused on the long term, even during periods of short-term disruption.
“Don’t let changes in interest rates drive strategic shifts in your clients’ fixed income allocation,” she said, adding that a client’s fixed income exposure should depend on the size of his equity exposure and his individual risk tolerance.