Bonds Still Have A Big Role To Play In Portfolios

By Karen Veraa, CFA

After 11 rate hikes, the Fed funds rate is at its highest level in 22 years - investors are able to get paid to hold fixed income investments. This higher rate environment creates a generational opportunity for bond investors.

While past returns don't guarantee future performance, bond ETFs have historically provided ways for investors to diversify portfolios, seek income and potentially preserve capital. Still, investors may need to rethink how they're using fixed income and the mix of bonds in their portfolios, as detailed below.

3 Ways Bonds Help Investors Meet Long-term Investment Goals

Income - What's fixed income without the income? Investors can use bonds to seek income as most bonds make payments, known as a coupon, to bondholders on a regular schedule. Since the Federal Reserve started raising interest rates, bonds can potentially provide more income. Depending on the asset class, bond yields have risen 3-4% with 3-month US treasuries yield 0.05% to 4.93% by July 31, 2023. High yield bonds have increased from 4.93% to 8.43% over the same time period.¹

Bond Yields: Year end 2021 and July 2023

Bonds with more credit risk, such as high yield or emerging market debt, may offer even higher levels of income, or yield. Credit risk refers to the likelihood a bond issuer will make their regular payments on time.

Diversification - Keeping bonds in the mix of your investments can potentially improve your overall long-term returns. As noted above, bonds have historically provided investors a counterbalance to stocks, especially in down years. History also suggests bond performance has tended to be good following periods of weakness in bond prices - which move in opposite direction as bond yields. The average three-year annualized returns of bonds following a three-year period in which they lost money is 11.6%.² Furthermore, bonds may potentially offer more income to buffer against future price drawdowns as the market adapts to higher interest rates and tighter financial conditions.

Capital Preservation - Bonds can be used to help preserve the value of your savings and potentially provide more yield than idle cash. Investors seeking this goal should consider their time horizon, liquidity needs and risk tolerance to any loss of capital. Shorter maturity bonds have tended to change in price less than longer maturity bonds and may be beneficial during periods of rising rates.

Celebrating The 20th Anniversary Of Bond ETFs

In July 2002, iShares launched the first bond ETFs with a Corporate Bond ETF and four Treasury ETFs. 21 years later, bond ETFs have grown to $2 trillion in assets under management. We now project that bond ETFs will reach $6 trillion by 2030.

Bonds still have a big role to play in your portfolio and bond ETFs are a low cost, efficient way to access them.

Actual and projected growth of global bond ETF AUM ($B)

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¹ Source: BlackRock and Bloomberg as of 7/31/2023 using the yield to worst on the ICE U.S. Treasury Core Bond Index and ICE BofAML US High Yield Constrained Index from 12/31/2021 to 7/31/2023.

² Source: BlackRock and Bloomberg using the 3-year annualized returns of the Bloomberg US Aggregate Bond Index from 1976 to 2022.

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Fixed income risks include interest-rate and credit risk. Typically, when interest rates rise, there is a corresponding decline in the value of debt securities. Credit risk refers to the possibility that the debt issuer will not be able to make principal and interest payments.

Non-investment-grade debt securities (high-yield/junk bonds) may be subject to greater market fluctuations, risk of default or loss of income and principal than higher-rated securities.

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This post originally appeared on the iShares Market Insights.