While the stock market typically captures most of the newsprint and the lion’s share of commentaries from pundits, bonds are key holdings in all our portfolios. Many of our clients look to bonds for portfolio protection, capital preservation, and/or a regular income stream to meet their current and future spending needs. Beyond these important benefits, bonds have significantly lower downside risks versus stocks.
Bonds are not one-size-fits-all investments though. Depending on a client’s investment preferences, time horizon, and the investing environment, we may recommend a range of fixed-income vehicles: core bonds (investment-grade government, corporate, and mortgage), flexible and absolute-return-oriented bond funds, and floating-rate loan funds. For clients in our Global Balanced portfolios, fixed-income investments currently make up 36.5% of holdings. Just looking at allocations though does not explain why we are positioned the way we are within fixed-income.
Our decision to shift more than half of our clients’ fixed-income exposure into flexible and absolute-return-oriented bond funds as well as floating-rate loan funds a few years ago was based on the limited return potential we saw for core bonds during a period of ultra-low interest rates. Yet, even though the Federal Reserve has begun raising interest rates to more normal levels, we have maintained our positioning. One reason for this is that these other types of fixed-income securities still look very attractive when compared to core bonds. Specifically, their higher yields provide more of a cushion against falling prices—bond prices fall as interest rates rise—and they show less sensitivity to interest rates. This much lower sensitivity means their prices face less of a hit from rising interest rates than core bonds do.
There is a catch. These types of investments come with greater credit risk, which means they are more vulnerable to losses during a market downturn. Even so, they offer an attractive balance of risk and reward that should enhance diversified portfolios. For instance, in the case of floating-rate loans, investment supply and demand dynamics are healthy and default rates are currently low. Additionally, the loans are secured by the borrowing company’s assets, and the interest rates paid adjust (float) at specified intervals in response to fluctuations in market interest rates. We have confidence in the ability of all our active fixed-income managers to navigate the risks.
We anticipate returns for more flexible bond funds as well as for high-quality floating-rate loan funds will far exceed those for core bonds. And our recent portfolio performance has borne this out. The core bond index returned only 2.5% in 2016; all but one of our fixed-income funds beat that, with returns ranging from 4.5%–8%. The first quarter of 2017 saw the same performance trend.
As interest rates rise, and assuming the global economy stays on its current growth trend, we expect core bond returns to remain low to negative and overall portfolio returns to continue to benefit from our positioning. As usual, we won’t rest on our laurels. We’ll continue to assess our fixed-income positioning so that if and when the investing environment shifts, we’ll be prepared to shift with it to ensure our client portfolios stay resilient and optimized to meet your investment goals.
Do you have questions or want to discuss our bond positioning further? Please call your Litman Gregory Wealth Advisor or contact us here.
Investment Key Takeaways—Year-End 2020
Very few (if any) market observers would have predicted a strong market outcome in early 2020, with pandemic fears rampant and the global economy falling off a cliff. But global stocks ended the year at all-time highs with a 16% gain. At Litman Gregory, we “stayed the course” during the volatility, and it proved prescient once again. In this post, we summarize key takeaways from our full year-end investment commentary, offering an overview of financial market performance and our outlook for the months ahead.
Commentary from Our CIO—Year-End 2020
In this year-end commentary, CIO Jeremy DeGroot reflects on the recent challenging and turbulent year and lays out our investment outlook for 2021 and beyond. The strong full-year market returns masked the incredible volatility and stress investors faced earlier in the year. While many risks remain, the early stages of vaccine distributions and economic stimulus are providing a light at the end of the tunnel.
Alice Lowenstein Earns CSRIC™, Sustainable, Responsible & Impact Investing Designation
We are pleased to share that Managing Director Alice Lowenstein has obtained the Chartered SRI Counselor designation, the first major financial credential dedicated specifically to sustainable, responsible and impact investing. This designation demonstrates Alice’s knowledge of SRI principles and best practices.