Is it time to reassess our view on bonds?
Recently Ray Dalio the founder of the world’s largest hedge fund firm said that he didn’t like bonds in a portfolio. He argued that they were too volatile for the low yield that they offered by explaining that one day’s price change could often be more than one year’s yield. With central bank throughout the world cutting rates to record lows it is not surprising. The US has zero percent interest rates, some European countries have cut to negative territory and even emerging markets who were the only ones providing decent yields are threatening to cut rates further.
It wasn’t that long ago, in 2007 to be precise that the Federal Funds Rate was at a decent 5.2%. Then the financial crisis hit and we have since then been stuck with close to zero rates. Although US government bonds provide very little interest they have shown to be precious in times of stock market declines like in March 2020.
Investment grade corporate bonds are lower in quality than government bonds but offer better yields. They are less volatile than stocks but offer little protection in market crashes. High yield bonds offer the worst credit quality but offer the highest yields. However, they tend to be as volatile as equities but have less capital appreciation potential.
Of course this quick take on bonds does not cover the full range of bonds out there such as, emerging market bonds, convertible bonds or cat bonds to name a few. However, the key takeaway is that low yields have diminished the appeal of bonds and therefore their allocation in portfolios should be reduced. Sovereign bonds offer very little yield and should probably be considered as protection against volatility. Corporate bonds offer better yields and better growth prospects and should probably be the core bond holding. High yield bonds which have a risk profile similar to stocks should be used primarily if there is a need for income but have little or in some cases no capital appreciation potential.