The New Face of Fixed In­come

The Western Star - - Science -

JUNE 2017

For the last 30 years bonds have helped boost port­fo­lios. With fixed in­come prices now fall­ing, it’s time to re­think how th­ese as­sets fit in a port­fo­lio.

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 fixed­in­come 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.

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