Since the 1980s, bonds have generally been on an extended bull run and have often generated capital gains with the falling rate environment, and 2020 was a part of it. Some investors may be concerned that bond yields are low on an historical basis and credit spreads are relatively tight versus government bonds. However, they should remember the benefits that bonds provide in a diversified portfolio, especially during periods of uncertainty and high volatility. There are opportunities and strategies within the global fixed income universe to help mitigate risk and generate income, which will certainly be useful in bumpy roads ahead.
During the equity debacle in March 2020, high-quality fixed income assets stood out and did what they were supposed to do, provide diversification from equities. And even when equities rebounded, bonds held up.
During economic downturn and equity market corrections, bonds have proven their usefulness by holding on while stocks were volatile. (table below)
Bond coupons provide a predictable and stable income for investors.
Bonds play an important role in a portfolio, by balancing risk and providing to a certain extent capital preservation at times of market stress. However, generating income returns and managing risk will, more than ever, require active and tactical management, in order to stand out in the years to come.
While it could be tempting to shy away from fixed-income investments in the current environment, being diversified in different fixed income assets and opting for strategies that can adapt quickly to changing market environments, can make a difference to portfolio returns compared to a more traditional approach.
While fixed income assets may not provide returns as high as previous years, there will always be bonds that will stand out from others depending on market conditions. Therefore, in an environment of a COVID vaccine-led reopening, the best performers may pro-cyclical asset classes like emerging markets (in local and US currency) and high yield bonds. However, if we see any volatility on the virus or vaccine front and markets were to move to a more risk-off stance, then higher quality fixed income should perform better.
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