How Low-Risk Bonds Help Hold a Portfolio Together

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June 19, 2017


Today’s investors face a frustrating dilemma when it comes to portfolio diversification: Traditional investing strategies dictate that investors should allocate part of their portfolios to fixed-income instruments – like bonds – to balance higher-risk investments – like equities.

 

“When growth assets don’t do well, bonds kick in and act as a smoothing mechanism over time,” says Eric Freedman, Chief Investment Officer for U.S. Bank Wealth Management. 

 

However, government bond yields presently sit at historic lows – 10-year Treasury notes, for example, were hovering at just 2.3 percent as of early May, and it is unclear if returns will rise soon, says Jennifer Vail, Chief Investment Officer, Institutional and Corporate Trust for U.S. Bank Wealth Management. 

 

Fixing to Flee

These limited returns have left investors discouraged, and many may potentially be wondering whether to abandon bonds altogether in favor of investments with a greater return. It is human nature to want to invest in assets that hold the promise of a higher return, but such decisions can have a big impact on a long-term portfolio strategy, argues Robert Haworth, Senior Investment Strategist for U.S. Bank Wealth Management.

 

“Migrating away from bonds may increase the volatility of your portfolio,” he says. “If you are going to do that, you have to decide how much risk you are willing to take to increase your returns.”

 

Before making any decisions on asset allocation, Haworth encourages investors to review their portfolio strategy with their financial advisor, with an eye on timelines, financial goals and appetite for risk — and to remember that goals don’t change just because the market is in flux. 

 

“Now is the time for investors to think about cost, risk and long-term needs, then to adjust their portfolio plans for the current environment,” he says.

 

 

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June 19, 2017


A Guide to Bond Options

In lieu of bond divestment, Freedman suggests reconsidering the types of bonds in the portfolio. When looking for bonds to add diversification with a lower risk profile, he suggests choosing from the following:

 

  • Government bonds. These are issued by stable governments with strong militaries and powers of taxation, including the United States, Germany, Japan and Canada.
  • Highly rated high-quality corporate bonds. Global companies with diversified product offerings and a long track record of stability and success.  
  • High-quality mortgage-backed security bonds. Bonds for both commercial and residential property mortgages can be good choices for diversification.
  • Bonds issued by government-sponsored enterprises. Organizations such as Fannie Mae and Freddie Mac provide credit and other financial services to the public and function as quasi-government entities.
  • General obligation municipal bonds. These bonds are backed by taxes from the issuing jurisdiction rather than by a specific revenue stream. For example, bonds to build schools, parks or roads are considered “general obligation,” whereas a bond to upgrade a toll road is dependent on revenues from toll payers and thus less predictable.

 

“Some investors think that if they load up on high-yield bonds, they are diversified, but that is not the case,” he says. While these types of bonds can add value to a portfolio, often they are as volatile as stocks and won’t provide the same type of balance investors are seeking to achieve with lower-risk-rated bonds. 

 

As always, these decisions ultimately boil down to risk management. Vail points out that “you need to maintain the stability of your portfolio for unforeseen events, like a delay in the release of a fiscal package or geopolitical risk. That’s the role bonds play.”

 

Investing in fixed income securities is subject to various risks, including changes in interest rates, credit quality, market valuations, liquidity, prepayments, early redemption, corporate events, tax ramifications and other factors.  

 

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