You might remember the 80s for its funny hairstyles, tight jeans and a variety of new-wave music. What may not come to mind is the start of a deflationary period that has created many happy bond investors.
Fast forward 30-plus years and the landscape is somewhat different – although funny hairstyles, tight jeans and experimental music still remain, creeping higher interest rates and signs of an inflationary environment means that gone are the days of viewing bonds as the path to greater returns.
So, then, what are they viewed as, and is there still a place for them in your portfolio?
A changing role
Simply put, when interest rates rise, bond prices fall. This is because investors won’t pay for a bond that has a lower interest rate, which ultimately decreases the value of the bond.
Beginning in the early 1980s, bond yields began to move lower as the threat of inflation subsided. This allowed investors to enjoy a combination of high current income and strong capital gains without much volatility – a trend that has been in place for several decades.
But now, with bond yields rising, fixed income prices are falling. As a result, their purpose in your portfolio is changing.
“The role that fixed-income plays going forward is really as a diversifier,” says Les Grober, Senior Vice-President and Head of Asset Allocation with Investors Group. “One of the big reasons investors still want to own bonds in their portfolio is that the correlation between bond prices and stock prices is still negative.”
Since bonds and stocks tend to move in different directions, from a diversification standpoint, owning bonds in your portfolio can reduce its overall volatility.
Since bonds and stocks tend to move in different directions, from a diversification standpoint, owning bonds in your portfolio can reduce its overall volatility.
“Bonds still provide a safe-haven,” says Grober. “They’re there to preserve capital, and provide diversification benefits and dampen down one’s volatility in a portfolio. That’s a significantly different role than what they’ve played in the past.”
Value of diversification
Steve Rogers, Investment Strategist with Investors Group Investment Management, highlights the value of this type of diversification.
“There’s always value in low correlation assets within a portfolio,” says Rogers. “Combining assets to improve returns, without increasing your risk, is key.”
A changing sentiment
Changing one’s view of the role fixed-income has been playing, from a portfolio booster to a diversifier can be a challenge for some investors, but adjusting your investment choices so they adapt to the current climate is important.
“We’re likely in the very early innings of an inflationary environment,” says Grober. “There’s big question mark about what that looks like and how we get there, but most people would agree that the deflationary risk we’ve been fighting since the financial crisis is ending.”
The new role that bonds can play in your portfolio is a good place to start, and advice from your financial advisor can help you make the decisions that are right for you.
This commentary is published by Investors Group. It represents the views of our Portfolio Managers, and is provided as a general source of information. It is not intended to provide investment advice or as an endorsement of any investment. Some of the securities mentioned may be owned by Investors Group or its mutual funds, or by portfolios managed by our external advisors. Every effort has been made to ensure that the material contained in the commentary is accurate at the time of publication, however, Investors Group cannot guarantee the accuracy or the completeness of such material and accepts no responsibility for any loss arising from any use of or reliance on the information contained herein. Investment products and services are offered through Investors Group Financial Services Inc. (in Québec, a Financial Services firm) and Investors Group Securities Inc. (in Québec, a firm in Financial Planning). Investors Group Securities Inc. is a member of the Canadian Investor Protection Fund.
