Extracting yield in the current market environment is a prime option for getting bond exposure. However, the risk associated with depreciating prices shouldn't put off prospective fixed income investors. Despite record issuance this year amid higher-for-longer inflation, investors may still express hesitance towards owning bonds.
Rate hikes may have soured the taste of owning bonds for their price appreciation benefits as the stock market continues to rally even in the face of high inflation/interest rates.
Still, the risk associated with owning bonds now could pay off in the long term. Especially if the economy starts to cool off. This makes bonds a relative value given their appreciation potential should the U.S. Federal Reserve finally reverse course and institute rate hikes.
“Stable interest rates with gradually falling inflation and economic growth of 2-3% could create an environment where investors will be rewarded for owning risk,” said Pramod Atluri, a fixed-income portfolio manager at Capital Group, in a Morningstar report. “However, given the strong outperformance of risky assets over the past year, I think staying heavily invested in risk isn’t prudent.”
Furthermore, given the high yields bonds offer today, it's easy to forget that they can still offer an ideal safe haven when the stock market turns awry. That volatility protection feature may have been lost in the 2022 downturn. Both equities and bonds trended lower, but the latter can still help absorb market shocks in the former.
“You can help smooth the volatility of your portfolio by introducing some bonds and doing so today,” said David Rogal, lead portfolio manager at BlackRock.
So if an investor eventually decides to allocate into bonds, where are the best opportunities given the current market environment? Short-term bonds have been an ideal choice in the past amid the Fed's rate hiking. And they still are a prime option today.
“We think this benefits the portfolio both in case there’s an unexpected shock where the Fed can cut rates, or if the deficit fears resurface,” Atluri says, noting that aggressive rate cuts could hurt long-term bonds more than their short-term counterparts.
2 Short-Term Options to Ponder
Vanguard has a pair of short-term bond funds to consider for broad-based exposure as opposed to holding individual bonds. One is the Vanguard Short-Term Corporate Bond Index Fund ETF Shares (VCSH). The fund seeks to track the performance of a market-weighted corporate bond index with a short-term dollar-weighted average maturity. It employs an indexing investment approach designed to track the performance of the Bloomberg Barclays U.S. 1-5 Year Corporate Bond Index. As of May 10, it offers a 30-day SEC yield of 5.41%.
Those who don’t want the additional credit risk of corporate debt can stay within the confines of safer Treasuries via the Vanguard Short-Term Treasury ETF (VGSH). It offers ideal exposure to short-term Treasury notes, focusing on maturity dates that fall within one to three years. Its 30-day SEC yield, also as of May 10, stands at 4.99%.
For more news, information, and analysis, visit the Fixed Income Channel.
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