Image by Schanin from Pixabay

Most investors would probably like to forget the poor performance of both bonds and equities in 2022 and early 2023.  For many, it was their first real experience of bonds falling in value, particularly at the same time as equities.  Different investors would have experienced different outcomes in 2022 (and subsequently) depending on the type of bonds that they held.  It is worth revisiting what has happened since then.

Going back to first principles, we can remind ourselves of several characteristics that apply to bonds:

• bond prices move in the opposite direction to bond yields i.e. when bond yields rise, bond prices fall;
• the prices of bonds with maturities further into the future are more sensitive to changes in yields than shorter-maturity bonds, making their prices more volatile;
• the lower the quality of the borrower issuing the bonds, the more like equities they behave;
• and finally, bond markets do not like inflation, generally driving up yields in the face of rising inflation.

In 2022, with the growing threat of high inflation following Russia’s invasion of Ukraine, exacerbated by the instability of the unfunded tax promises of the government under Liz Truss, bond yields rose dramatically and substantially.  The bond see-saw moved violently, with those owning longer-dated bonds suffering material and painful falls in value.  Those who owned shorter-dated bonds fared better, but even so delivered falls in value.  Yet, bond owners from that point on began to benefit from the higher yields that their bonds now delivered, recouping some of those falls in value.

Take a look at the chart below, which shows how far bonds fell for different maturities and what the return has been in cumulative terms (including yields) since the start of the fall.  As you can see, shorter-dated bonds have bounced back to where they started, while longer-dated bonds still sit deeply underwater.

Figure 1: Bond falls and recoveries vary depending on what you own

Source: Morningstar Direct © All rights reserved – see endnote for details.

It is evident that shorter-dated bonds have recovered far more quickly than longer-dated bonds as the prices of the former fell less far, and the consequent higher yields have helped to recoup these falls, at least in nominal, pre-inflation terms.  At their worst, shorter-dated global bonds were down around -7% in 2022. However, they delivered just over 5% in 2023 and around +1% to the end of June this year, following small yield rises across major markets.

We have always tended to favour shorter-dated bonds in our portfolios for this reason believing that the small premium available in lending for longer is outweighed by the downside protection that comes from owning shorter-dated bonds alongside their bounce-back-ability!  For inflation-linked bonds, we are constrained by the availability of index-linked gilts, and the maturities tend to be intermediate (5-15 years) due to the number of holdings required in a fund.  However, we have still seen higher yields and returns of around 6% in 2023.

2022 reminded us all of why equity-like risk, such as the drawdowns of longer-dated bonds that year, belong in the growth assets allocation of a portfolio.  Short-dated, high-quality bonds are now back where they started at the beginning of 2022.  Nobody knows where the market will move next, but short-dated bond investors can enjoy the prospect of 5%pa interest rates for lending their money, at least for now!

This blog is intended for information purposes only and no action should be taken or refrained from being taken as a consequence without consulting a suitably qualified and regulated person.  Your capital is at risk when investing.  Past performance is not a reliable indicator of future results and forecasts are not a reliable indicator of future performance.

Data series used:

Use of Morningstar Direct© data

© Morningstar 2024. All rights reserved. The information contained herein: (1) is proprietary to Morningstar and/or its content providers; (2) may not be copied, adapted or distributed; and (3) is not warranted to be accurate, complete or timely. Neither Morningstar nor its content providers are responsible for any damages or losses arising from any use of this information, except where such damages or losses cannot be limited or excluded by law in your jurisdiction. Past financial performance is no guarantee of future results.

The post Bonds, a bounce back for some appeared first on The Financial Bodyguard Blog Site.