Bond returns were negative in the first half of 2022, alongside negative returns over this period from riskier asset classes like equities. But history shows that, at times such as these, we can expect bonds to start behaving as a hedge to equities again. At current yield levels, bonds are able to absorb further yield rises before total returns from the asset class become more negative again.
For example, a portfolio of high-quality short-maturity fixed income bonds currently delivers a yield of 3.9% with a duration of 3 years (source: Bloomberg Global Agg Corp 1-5 years). It would take a yield rise of approximately 130 bps before total returns start to become negative again. While for the longer-duration portfolios the sensitivity to rising yields is higher, the increased yield cushion has materially improved break-evens.
There are other reasons why we think bonds will behave as bonds again, and provide diversification against equity market volatility.
As much as bonds hate inflation, they love recessions. Historically, bonds have outperformed equities in a recession. Recession risks are more elevated today compared to a year ago, which should be more supportive for bond prices while potentially being negative for equity prices. Thus, bonds could go back to being a diversifier in an environment of weaker economic growth.
History shows that bonds have been a good diversifier to equities. For example, in years with negative equity returns such as 1992, the period 2000-2002, 2008 and 2018, bond prices rose (source: MSCI World and Bloomberg Global Aggregate Bond Index, USD hedged), providing diversification in a challenging environment for equities. Even so far in 2022 (the year to 31 July), while equities suffered a drawdown of 14%, bond returns declined by a more tempered 6.7%, showing that bonds have a role in limiting volatility even when they decline at the same time as equities.
Aside from the diversification benefits that bonds can provide, investors also recognize their income-generating ability and have historically allocated to this asset class to benefit accordingly. Typically, the yield is the most important determinant of longer-term bond returns, but in the low and even negative yield environment experienced in recent years, capital gains were the more important driver of fixed income returns.
The good news is that, with the rise in yields, bonds are back to providing income for investors and yields will again be a dominant driver of fixed income returns. Higher yields now mean higher income for bond investors in the future. While yields on government bonds are starting to look attractive, credit spreads have also widened substantially and now offer a more compelling compensation for credit risk. This compensation is warranted in light of heightened recession risk and tighter financial conditions. It is not yet clear whether inflation will come down meaningfully and fast.
With more uncertainty ahead, we believe that high-quality credit investments with a low risk of default offer good value for investors. In our view, bank and insurance debt looks cheap and cross-over credit (BB/BBB) offers appealing investment opportunities, too.
Bond holders have so far had a difficult time in 2022 as a surge in inflation and rising interest rates have pushed total returns for bonds into the red, alongside poor performances from other asset classes. But, with the repricing of bond markets, bond yields have also risen sharply and now provide an attractive entry point from which to build back bond exposure in a portfolio.
Higher rates and credit spreads could enable bonds to provide higher income for investors in the coming years. History shows us that, over the long term, bonds have provided diversification and have helped to reduce portfolio volatility. This is because they can provide positive returns in years when equity markets decline. As the economic outlook is becoming more challenging, we think it is very likely that bonds could go back to being a hedge against equity market volatility. Investors should therefore consider building back bond exposure.
The information contained on these pages is for marketing purposes and solely intended for Qualified Investors in accordance with the Swiss Collective Investment Schemes Act of 23 June 2006 (“CISA”) domiciled in Switzerland, Professional Clients in accordance with Annex II of the Markets in Financial Instruments Directive II (“MiFID II”) domiciled in the European Union und European Economic Area with a license to distribute / promote financial instruments in such capacity or herewith requesting respective information on products and services in their capacity as Professional Clients.
The Funds are domiciled in Luxembourg and The Netherlands. ACOLIN Fund Services AG, postal address: Affolternstrasse 56, 8050 Zürich, acts as the Swiss representative of the Fund(s). UBS Switzerland AG, Bahnhofstrasse 45, 8001 Zurich, postal address: Europastrasse 2, P.O. Box, CH-8152 Opfikon, acts as the Swiss paying agent. The prospectus, the Key Investor Information Documents (KIIDs), the articles of association, the annual and semi-annual reports of the Fund(s) may be obtained, on simple request and free of charge, at the office of the Swiss representative ACOLIN Fund Services AG. The prospectuses are also available via the website www.robeco.ch. Some funds about which information is shown on these pages may fall outside the scope of the Swiss Collective Investment Schemes Act of 26 June 2006 (“CISA”) and therefore do not (need to) have a license from or registration with the Swiss Financial Market Supervisory Authority (FINMA).
Some funds about which information is shown on this website may not be available in your domicile country. Please check the registration status in your respective domicile country. To view the RobecoSwitzerland Ltd. products that are registered/available in your country, please go to the respective Fund Selector, which can be found on this website and select your country of domicile.
Neither information nor any opinion expressed on this website constitutes a solicitation, an offer or a recommendation to buy, sell or dispose of any investment, to engage in any other transaction or to provide any investment advice or service. An investment in a Robeco Switzerland Ltd. product should only be made after reading the related legal documents such as management regulations, prospectuses, annual and semi-annual reports.