A New Normal for Bond Investing

The days of bond investing being as exciting as watching paint dry are long over. Once the predictable and boring part of an investment portfolio, bonds have been anything but since 2008. In the thirty years prior to the financial crisis, one could fall out of bed and make a decent return on their bonds. That is no longer the case.

More than a decade of zero or near-zero interest rates and unprecedented Federal Reserve quantitative easing (buying bonds to provide liquidity and to stabilize markets) made the bond market challenging to navigate and to find consistent returns. After finally raising short-term interest rates to 2.25% by mid-2019 and after gradually beginning to unwind its balance sheet, the Fed was suddenly forced in 2020 to drop rates to zero once again and to reengage in quantitative easing due to the global pandemic. Those actions resulted in far better than expected bond returns this past year.

With 2020 behind us and the end to the pandemic somewhere on the horizon, what are the prospects for bond returns going forward? Short-term rates likely cannot go any lower. And we have already seen an increase in longer-term interest rates, indicating the market’s expectation that the Fed will have to raise rates sometime in the future. In this environment, it is critically important to not only have the appropriate mix of bonds but to also use managers with the ability and flexibility to adapt accordingly. With this in mind, we would like to share upcoming updates we are making within the bond allocation.

The Coming Updates

In spring 2019, we made several updates to your bond portfolio knowing that the equity bull market and economic expansions were long in the tooth. While we certainly could not have predicted that a global pandemic would be the trigger, we believed that any disruption the stock market or slowdown in the economy would favor bonds – especially those that were less correlated to stocks and more defensive in nature:

• Two of the updates made in 2019 were to add Guggenheim Total Return and Vanguard Intermediate Treasury. The former added a more active, nimble manager to our portfolio and a nice complement to PIMCO Total Return. The latter was added for stability and defense in the event of a market downturn and/or recession.
• Both Guggenheim Total Return and Vanguard Intermediate Treasury did exactly what we expected. Guggenheim’s total return approach proved incredibly successful in 2020. Vanguard provided stability, especially when both the stock and bond market dropped last March, rates fell, and investors rushed into the safe haven of US treasury bonds.

Now that the worst is behind us, markets have settled down, and interest rates remain near zero, we believe the time is right for additional updates:

• Shift out of the Vanguard Intermediate Treasury in tax-deferred (or low tax rate) portfolios in favor of additional allocations to Guggenheim Total Return and BlackRock Strategic Income.
• In taxable portfolios, we will reduce exposure to Vanguard Limited-Tax Exempt or Individual Municipal Bonds in favor of an increase in exposure to BlackRock Strategic Income.

Here is a summary of the updates:

Why Now?

One goal of these updates is to eliminate the pure treasury position in your portfolio. This is not because we do not want to have treasuries at all. This piece did its job admirably when we needed it to, and you will still have exposure to treasury bonds inside some of the other funds in your portfolio. However, given current interest rates, there is not a great risk/return trade-off from holding pure treasury securities.

Another goal is to increase exposure to managers that have a more active approach (Guggenheim) and a more open, flexible mandate (BlackRock) to capture changing dynamics more quickly in the bond market like rate movements, changes in spreads, and inflation. At the end of the day, we want your bonds to continue to behave like bonds. They should mitigate the risk of your stocks and they should provide reasonable returns even in a low interest rate environment. We believe these updates accomplish that.

We will implement these updates in the next couple of weeks.  Since we utilize asset placement to enhance  after-tax return, the updates may impact tax-deferred accounts, taxable accounts, or both.