Investors are at that point in their long, messy bond breakup where they teeter on a bar stool, savor their third martini of the evening, and ask their dearest friend if he’d be crazy to try again. the relationship ?
It certainly hasn’t been a happy marriage this year. After four decades of stability, ballast in times of uncertainty and reliable returns (in nominal terms at least – no relationship is perfect), government bonds have done the dirty work of fund managers in 2022.
Soaring and persistent inflation has dealt a heavy blow, eroding the fixed interest payments that bonds typically provide and lining up a series of surprisingly aggressive benchmark interest rate hikes. It’s bad enough: since the 2008 crisis, fund managers were conditioned to expect extremely low levels of inflation and supportive central banks.
Of course, investors have complained about bonds in the past, especially when benchmark interest rates fell so low that yields turned negative, meaning fund managers ended up buying them knowing with certainty that they would lose money if they held them to maturity.
But this year has been particularly cruel. Even very long-term government bonds were affected. That’s unusual in itself, especially with a potential recession around the corner, and weakness in this pocket of the markets has chewed up and spit out investment products labeled as extremely safe. These things are meant to be boring and reliable. They are not supposed to lose your savings.
It is not only the long-term public debt that is to blame. The Bloomberg US Aggregate Index, made up of a range of dollar debt, has fallen about 13% so far this year – comfortably its worst year in decades.
And the real insult is that bonds failed at one of their most basic jobs in a portfolio: they fell along with stocks. Brief periods like this do happen, but not that long. It turned a bad year for investors into a terrible year.
But after this historic rout, investors are slowly coming back. Ten-year US Treasuries, to choose the global benchmark, yield 3.7%. That’s a big deal, and it’s well above the 1.6% we started 2022 with.
Could prices drop further? Of course, if inflation rises again. “Inflation is incredibly difficult to predict,” said Emiel van den Heiligenberg, head of asset allocation at Legal & General Investment Management. “You have armies of doctors studying this in central banks and they get it wrong all the time.”
Still, yields are now decent, often without having to take on significant default risk, and if the worst happens (a recession, for example), the price will soar, mitigating the likely blow from falling stocks. “One of the reasons for holding bonds is the buffer,” says van den Heiligenberg. “It still stands.”
Some, understandably, hesitate. James Beaumont, head of multi-asset portfolio management at Natixis Investment Management, says he was underweight relative to benchmarks in US and European government bonds all year. Now it is sinking again, especially on the American side. “We’re adding back towards neutral and it’s a more attractive investment proposition, but we’re not even neutral yet,” he says. “Can I see us doing this next year?” Yes, but not yet.
Others are more enthusiastic. “Bonds are back,” enthused JPMorgan Asset Management in its latest long-term outlook. Pimco, one of the largest bond funds in the world, is of course always predisposed to see the rise of this asset class. Yet Chief Investment Officer Dan Ivascyn’s “call to action,” as he describes it, is striking. “Value has returned to fixed income markets,” he said this week. “Just thinking about nominal returns, we’re going to start here in the United States. . . you can look for a very high quality spread product and very, very easily build a portfolio in the 6, 6.5% type yield range, without taking a lot of exposure to economically sensitive assets.
The now steady stream of information on the outlook from major banks and asset managers also suggests that a debt tie-up is within reach. “In high-quality bonds, we see broad-based strength,” the Morgan Stanley team wrote. Assets such as Treasuries and German Bunds, but also a handful of corporate and other bonds “all allow investors to ’embrace income,'” he added.
Goldman Sachs offers a naturally balanced message, given the wide range of potential results next year. But he also says “there is more yield to offer – in real and nominal yields than for a few decades. It can seem boring to structure portfolios around getting that yield, rather than hitting the prospect.” strong capital appreciation, but it can also be a return to more conventional investments.
UBS Wealth Management, meanwhile, advises its clients to “look for income opportunities.” “In US investment grade, yields are around 5% – a level we find attractive and should provide a buffer against volatility,” he says.
All in all, it’s not exactly a dramatic romance revival. But investors dare to believe that the bond relationship might be worth another shot.
katie.martin@ft.com
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