COMEBACK: Bonds are world’s biggest traded asset class, at c$130 trillion, and one of its most liquid. They fell sharply out of investor favour last year. Many saw worst ever performance (see chart). Hit by double whammy of the global inflation and interest rate shock. And high valuations after a multi-decade rally. This has opened up opportunities this year. Of newly attractive bond yields vs US savings accounts offering only an average 0.3%. Or outlook for peaking interest rates and lower inflation offering potential bond capital gains. Or for those seeing a return of the classic 60:40 portfolio diversification. But not all bonds are equal. They have very different credit and inflation risks. From the safer haven BIL’s to longest duration TLT exchange traded funds.
FLAVOURS: The bond market can be divided many ways, with widely different characteristics. By type, between government, corporate, mortgage backed, and inflation linked bonds. By inflation or duration risk, from 3 months through to 20 years. Or by credit risk, from investment grade to high yield. From big ETFs like short term US government bills (BIL) to the longest-term US government bonds (TLT). From inflation-indexed government bonds (VTIP) to riskier high yield corporate bonds (HYG), as well as all-weather all-encompassing bond exposures (BND).
BASICS: With its income fixed a bond’s sensitivity to inflation can be high. The longer the term, or duration, the greater the risk this is eroded by inflation. US inflation is likely to keep easing, ultimately to the Fed’s 2% target. Credit risk is the other major risk. This is near zero for government bonds, despite jitters on the looming debt ceiling. The risk is clearly higher for corporate bonds. But even here, near-term earnings and economic resilience have surprised.
All data, figures & charts are valid as of 01/03/2023