Bonds held within your pension plan, or investment bond, are usually dependable and typically sit quietly as part of a multi-asset fund, with lower-risk investors holding higher percentages over equities.
Bonds provide low to medium, but steady returns and a reliable stream of income, that can be invested over time, and typically act as shock absorbers during equity market declines.
That said, however, bonds have not been a safe port in recent times, in fact recently, stocks and bonds have been falling in tandem for much of 2023.
So very understandably, many lower-risk investors are surprised by the recent sharp drop in the value of even Cautiously Managed funds.
In this blog, we will provide our perspective on the bond market’s performance and explain what various fund managers are doing to navigate your portfolios through this period of turbulence.
How Bond Funds Recover – Recent Markets
As previously mentioned, normally bonds move in the opposite direction to equities, but in recent times, these usually reliable bonds have been experiencing unusually heightened volatility.
The culprit for the sharp decline in the bond market is rising interest rates. Bond prices and interest rates move in opposite directions. When interest rates rise, prices of existing bonds fall, even though the coupon rates remain constant, and yields go up relative to the price of the bond.
So, how do Bond Funds Recover when they have fallen in price?
The answer is that there are several ways in which bond funds can recover:
- If you are invested in actively managed funds, a key active option for the fund manager is to lengthen duration i.e., to swap lower duration bonds for longer duration availing of lower prices and better capital increases, if interest rates fall.
- A higher yield means, that going forward, coupons on existing bonds can be invested at a higher rate, as new bond investments also earn a higher coupon.
- Capital value & income return, both feed into the performance of a bond fund over the long term, like dividends in an equity fund.
Broadly speaking over the longer term, bond total returns are driven more by income return (reinvestment of interest income and compounding) than by price, but it’s important to understand that in a period of lowering rates, then, capital gains could add more than coupon and vice versa.
Then, the other side to this coin, is that we are probably at peak interest rates and consequently, yields at their current level offer much more protection against future losses.
How Bond Funds Recover – Looking Forward
Forecasting the future is notoriously difficult and the current investment environment is particularly uncertain and may be relatively stagnant in 2024. But, with that said, many of the best investment returns have followed periods of extreme discomfort for investors. That is why time, not timing, has proven to be the key to building wealth and reaching long-term goals.
So, in conclusion, staying diversified to protect against what we don’t know helps to mitigate risk and volatility in portfolios. Although bond returns have been disappointing over the past year, they can recover, and they will continue to play an important role in well-diversified portfolios going forward.
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Contact: Ken O’Gorman – Director – QFA, CB, SIA – Investment Specialist
One Quote Financial Brokers on 01 845 0049 or email: ken@onequote.ie
