Is There Still a Place for Bonds When Rates Rise?

I understand that people are worried about higher rates, but it does surprise me that investors are so concerned about their bond holdings right now. The reality is that it’s actually stocks that generally get hit harder when rates rise precipitously.

Bonds’ Role Hasn’t Changed

First, let me provide some perspective on bond investing in general. When you find yourself second-guessing your bond allocation, remember to ask yourself why you hold fixed income investments in the first place. The typical reasons are diversification, yield and as a hedge against stock market risk. It turns out that those are all still valid rationales today.

In terms of total return, bonds may not appear as attractive as when you first invested in them. But relative to equities, they have certainly been doing their job with respect to diversification and as a risk hedge.

Bond Funds ≠ Bonds

Additionally, remember that holding a bond fund is not the same thing as holding an individual bond security. That’s relevant because a bond fund will reinvest the coupon payments and maturing securities in its portfolio at the new, higher rate, so the fund will typically reflect the increase in prevailing yields faster than many investors realize.

Our Bond Positioning

Next, let’s address fixed income positioning in our own multi-asset portfolios. We remain neutral on stocks relative to bonds from an asset allocation point of view. Basically, we don’t see an argument to favor one over the other right now and are not shifting away from our neutral, long-term strategic allocations.

And what about cash-equivalent investments, like money markets? Well, although “cash is king” when returns for other asset classes are negative, money markets are virtually the only guaranteed losing investment in real terms (that is, net of inflation) over any longer-term horizon. They are simply not designed to keep up with the average rate of inflation over time.

Now, let’s turn to positioning within our fixed income slice. We intentionally and deliberately diversify our bond holdings by geography, duration, sector, credit, inflation hedging, etc. This means, for example, that we are well-positioned to handle, let’s say, yield increases in 10-year Treasuries.

Additionally, we have been and continue to be underweight duration (price sensitivity to interest rate changes) in our fixed income portion of our portfolios. That has reduced our exposure to recent longer-term rate increases.