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.
Gretchen Hollstein and Monica Muñoz Named to 2021 Top Wealth Advisor Moms List
We are pleased to announce that Senior Advisors Gretchen Hollstein, CFP® and Monica Muñoz, CFP® have been named as two of the country’s Top Wealth Advisor Moms for 2021 by Working Mother. This recognition is a testament to their passion for both roles they hold, advisor and parent.
Commentary from Our CIO—Third Quarter 2021
Chief Investment Officer Jeremy DeGroot reviews key elements of the global macro environment and how they impact our financial market outlook: COVID-19, U.S. economic policy, growth, and inflation. He also covers our reasons for near-term caution on U.S. stocks, and an in-depth review of emerging market equities, in light of recent market headlines and regulatory developments in China.
Introducing Litman Gregory’s Updated Logo
For many years, our team has referred to the services we offer to our clients as "wealth management". To us, this communicates that we provide both investment management and financial planning in an integrated way to support their broader wealth planning goals. As of today, we have officially updated our name and logo.