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Who said bonds are boring?

Our expert states his case for bonds in today’s context. Read on to get more insights.

May 9, 2024

23 mins

by:

Manpreet Gill Chief Investment Officer of Africa, Middle East and Europe

Wealth Insights: Who said bonds are boring?

Investors often tell me bonds are boring. Regardless of whether the issuer is the US government or an exciting technology company, bonds pay the stated yield over their life and repay principle at maturity. For much of the 2009-2020 period, bonds were made even more ‘boring’ by the fact that yields themselves were very low. In 2020, for example, the yield on the 10-year US government Treasury bond fell below 0.50%.

Today, bonds are arguably a little less boring. The 10-year US government bond yields well over 4% and different types of corporate and Emerging Market bonds offer more. While there has undoubtedly been some price volatility so far in 2024, we believe a strong case exists today to include the so-called ‘boring’ high quality bonds in a core investment portfolio to take advantage of these yields.

Putting things in context

The debate over inflation remains key to recent bond volatility. While inflation remains on a medium-term downtrend since it peaked a couple of years ago, there has been a mini-resurgence this year. This, in turn, has created some uncertainty about whether the Fed will be able to cut rates this year, causing bond yields to back up higher (and bond prices to fall). However, we believe fixating excessively on short-term volatility misses the broader point – that locking in an attractive yield remains key to attractive (and boringly consistent) long term returns on bonds.

Getting the right starting yield

At risk of stating the obvious, when buying bonds, the starting yield remains one of the most important factors that drive future returns in the long run. The chart below helps illustrate how tightly 10-year returns closely mirror the yield on the bond 10 years ago, despite all the price volatility experienced over the 10-year holding period.

This point gets to the heart of why we believe today’s yield levels in US Dollar-denominated bonds represent an attractive entry opportunity. To put this in context, the level of nominal yield available today was last available in 2007. We also know from history that US bond yields tend to peak not far from the peak in Fed policy rates. Overall, what this tells us is that while short-term volatility may come and go, today’s bond yields likely represent an opportunity to lock in an attractive yield for the long run.

Fig. 1 Today’s higher starting yields point towards higher bond returns in the coming years
Bloomberg US Aggregate Bond Index 10-year annualized returns vs starting yields

Wealth Insights: Who said bonds are boring?

Source: Bloomberg, Standard Chartered.

Getting real

Many investors rightly point out that it is often not just about the nominal yield, but the ‘real’ one, i.e., the level of inflation-adjusted yield that matters the most.

On this measure as well, US bonds look attractive. Using the yield on inflation-protected bonds as a guide, the real yields available today were last achievable in 2008. While this again tells little about whether they have peaked or could go higher in the short term, over a longer holding period they do suggest a very good chance of earning a healthy return on the bonds over the inflation rate.

Over long cycles, investment portfolios are usually best hedged against inflation via either equities or ‘real assets’, such as gold or other commodities. Of course, we still believe these assets play an important role in an overall portfolio, but we would not want to pass on an opportunity to earn inflation-beating yields from bonds as well.

Stay diversified, keeping a core holding in bonds

One investor habit I have written about before is home bias. As investors, we tend to buy what is close to home and familiar. However, as reams of studies since the 1960s have pointed out, buying what is comfortable is not always the best investment decision. Having a reasonable amount of diversification, including across a diverse range of domestic and international assets, is key to creating a portfolio that is more resilient to unexpected volatility. Additionally, studies show a globally diversified investment allocation has been more profitable for investors than those whose portfolios have been concentrated in historically low-return markets.

While we remain advocates of well-diversified portfolios, within this, we see an opportunity today to build a core investment in high quality bonds. The highest level of bonds yields in over a decade, while attractive in itself, also present an opportunity for capital gains if the yields fall from current high levels over the coming years as the economic cycle turns down. In that sense, for long-term bond holders, they mitigate the risk of any short-term upside in yields. Bonds can be seen as boring indeed, but for investment returns this is a characteristic to be harnessed.

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