The steps taken by the central banks lifted all interest rates. During ‘the rise of the rates’, bond holders were hurt because the value of their bond holdings (seriously) declined. The year 2022 is recorded to be one of the most negative for bond holders. Also, the year 2023 has not been a successful year for bonds. The total return hovers around 1% - 2%. There are exceptions: high yield bonds have performed quite well; their performance in the US this year has been around 6% - 7%.
Nevertheless, the Saxo Strats believe that most of the interest rate hikes are done, especially in the US. This results in a limited downside risk for the price of bonds, and this makes the current yield attractive. And in the scenario where the rising interest rate flips to declining interest rates, the bond holding will even appreciate in value.
Benefits of adding bonds to the portfolio
There are several benefits of adding bonds to the portfolio.
- Diversification: Bonds tend to perform differently than stocks, so adding bonds to a portfolio can help reduce overall volatility and risk. Bonds can provide stability when stock prices decline.
- Income: Bonds provide regular interest payments that can serve as a source of income for investors. This income can be used to fund living expenses or be reinvested. This is especially attractive for people in retirement.
- Stability: Most bond coupon payments are fixed, so they provide a steady stream of income that is not affected by economic changes. This contrasts with stock dividends, which can vary.
- Lower risk: Bonds are generally less risky than stocks, especially high-quality government bonds, which have minimal default risk. Bonds can help offset the higher risk of equities.
- Principal preservation: Holding bonds to maturity allows investors to recoup their principal investment amount. This provides a safety net against potential stock losses.
In summary, the key benefits of adding bonds to a stock portfolio are increased diversification, stable income, lower portfolio volatility, and principal protection. Bonds can balance out some of the risks associated with equities.
How much to invest in bonds
This depends on the profile of the individual investor. Things to consider are age, investment horizon, risk appetite and investment goals. What can be said though in general is: the older you are, the higher the percentage of bonds will be. This approach can also be recognised by the pension funds. For younger participants, stocks will be overweight whereas, because retirement comes closer, older participants will be overweight bonds. The rule of thumb here could be: invest your age – as a percentage – in bonds. Investors can (and will) deviate from this approach, but the underlying message is clear. The older you get, the more one normally invests in bonds.
Correlation with stocks
Bonds can provide diversification from equities. Bonds often move differently than stocks, so combining the two asset classes can smooth out a portfolio's returns over time. Bonds may rise when stocks fall, helping cushion the impact. In the graph below, you can see how the correlation between global stocks and bonds has been for the last 60 years.