In late 2013, the 10-year US Treasury yield hit 3%, spooking investors who thought the bond bubble was bursting. Prognosticators urged investors to abandon bonds. And thenâthey waited.
Just as Linus chose to wait for the Great Pumpkinâs arrival on Halloween instead of trick-or-treating with his friends, investors who elected to wait it out in 2014 and remain underweight fixed income in their portfolios have also been left empty-handed, while their fellow investors earned a respectable 4% in core bond strategies.*
Nothing to Fear
While possible reasons exist as to why bonds have performed better than expected this yearâfor example, concerns regarding the pace of the US economic recovery, lingering worries over the euro area, and the magnitude of the slowdown in Chinaâthereâs an important lesson to be learned: Bonds are not to be feared, and investors who are thoughtful when it comes to their fixed-income allocation have the fullest basket of treats.
As I mentioned in a previous blog post, when yields do eventually rise, it wonât necessarily be bad for fixed-income investors. In fact, for most investors, especially those needing income, rising interest ratesâand bond yieldsâwould be a good thing. The value of higher yields is realized through timeâand thatâs where investors make money in fixed income. Over time, bond portfolios are unlikely to suffer the way some headlines would have us think, and investors will likely have positive returns even if rates rise.
And there are even more advantages to rising interest rates.
As was the case earlier this year, during a steep yield-curve environment, yield-curve âroll,â or a bondâs price increase as it moves closer to maturity, can cushion the impact of escalating rates and falling prices. Plus, as long as your fixed-income portfolioâs duration is shorter than your investment horizon, rising rates can boost your total return over that horizon. Bondholders can especially benefit if interest rates rise by less than whatâs priced in with market expectations.
Stop Waiting in the Pumpkin Patch
No one knows the path of future rates with certainty. Our advice is to stop paying attention to day-to-day movements in prices and waiting on when rates may rise. Investors who do so are missing the big picture. Sticking to long-term asset allocation goals is key. You may or may not see higher yields, but itâs not such a bad thing if it happens. In reality, itâs in investorsâ best long-term interests, and not so scary after all.
* Barclays US Aggregate Bond Index was up 4.1% year to date through September 30, 2014.
The views expressed herein do not constitute research, investment advice or trade recommendations and do not necessarily represent the views of all AllianceBernstein portfolio-management teams.
Douglas J. Peebles is Chief Investment Officer and Head of Fixed Income at AllianceBernstein (NYSE:AB).
