Harvey Jones
20.03.2023

Yields are back. It’s time to buy bonds while they’re still cheap
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Think of the bond market as a sleeping giant. Everybody knows it's there, but only a few obsessives pay much attention to it.
Until the giant rolls over, that is. Then the earth shakes beneath all our feet, even if we don't always understand why.
The bond market was tossing and turning throughout 2022, and investors are still feeling the aftershocks today.
It’s on the move again and this may throw up a huge buying opportunity. Before investors take advantage, they need to know how this powerful giant behaves.

Know your bond market

Bonds are a form of debt that governments and companies issue to raise money to cover their spending.
They pay a fixed rate of interest with a pledge to return all capital at the end of a pre-agreed term.
Investors don't have to hold bonds all the way through to maturity but can buy and sell them at any time, like any other asset.
When bonds are in demand, prices rise and yields fall. When they’re out of favour, the opposite happens.
As central bankers slashed interest rates ever lower, bond yields plunged towards zero, and in some cases below.
An estimated $15 trillion of global bonds were trading on negative yields at one point, where investors paid issuers for the dubious privilege of holding them.
At the same time, bond prices soared.
The bull market in bonds lasted more than 30 years, but came to a sudden end last year, when inflation took off and panicky central bankers started jacking up interest rates in a desperate bid to stop the economy from overheating.
Suddenly our sleeping giant was making all sorts of worrying noises and the bond market suffered the worst sell-off since 1949, according to Bank of America.

Prices crashed. Investors got wiped out. Our sleeping giant had finally roared.

Bond market crash

Bonds are supposed to be a low-risk asset class offering a fixed rate of income with some capital growth.
The big appeal is that they do not correlate with equities. Typically, when equities rise, bonds fall and vice versa, which helps mitigate the risk of investing in shares.
This gave rise to the classic 60/40 portfolio, a cornerstone of financial planning for decades. Investing 60 per cent in shares and 40 per cent in bonds should minimise volatility and maximise overall returns, financial advisers assured clients.
And it worked, by and large, until last year, when shares and bonds did the unthinkable and crashed at the same time.
Both were hit by rocketing inflation and interest rates, but as inflation now appears to have peaked, last year’s meltdown looks like going into reverse, and that’s where the bond buying opportunity arises.
Investors who are still worrying about last year's crash are likely to miss out.

Return of the yield

“Yields are back,” says Jean-Yves Chereau, partner and portfolio manager on the J. Stern & Co. Multi-Asset Income Strategy. “Better still, it looks like they may be here to stay, at least for a while.”
Investors can now purchase US Treasuries yielding anywhere between 4 per cent and 5 per cent, Mr Chereau says.
Better still, they can invest with minimal risk as 2022’s “savage sell-off” is done and dusted. “Last year was exceptional by any standards and the asset class remains less volatile and relatively safe today,” Mr Chereau says.
If inflation and interest rates fall, then locking into a fixed rate of interest today should prove highly rewarding.
Something else is happening.
Bonds are issued with different maturities, which can be anything from a few months to 25 or 30 years.
Usually, the longer the maturity the higher the yield, as investors demand a premium to cover the interest rate risk.
Right now, it’s the other way round, in what is known as an “inverted yield curve”.
“Somewhat uniquely, two-year US Treasuries now yield almost 5 per cent, with 10-year Treasuries notably lower at around 4 per cent,” Mr Chereau says.
This allows investors to double down on their buying opportunity.

No more sleepless nights

Investors should embrace the inverted yield curve, says Alex Harvey, fund manager at Momentum Global Investment Management. “It gives them a superior yield but without the interest rate risk of investing in longer duration bonds.”
Most private investors do not buy individual bonds but spread their risk and get diversified exposure with an actively managed mutual fund or exchange traded fund (ETF).
There are scores of ETFs that give investors targeted exposure to different parts of the yield curve.
Investors wanting short-dated bond exposure might consider iShares iBonds Dec 2025 Term Treasury ETF, Schwab Short-Term U.S. Treasury ETF, Vanguard Short-Term Treasury Index ETF or SPDR Portfolio Short Term Treasury ETFs.
Short-dated bonds may look attractive today, but Mr Harvey says investors might still want to balance them with longer-dated exposure, too.
If inflation continues to fall then two-year bonds may mature at a time when yields are lower and bond prices higher than today, leading to what Mr Harvey calls “reinvestment risk”. “In that scenario, the upside opportunity from owning longer duration bonds will increase.”
Balancing short and long duration bonds could deliver both capital upside opportunities and diversification benefits, he adds.
Again, there is a wide choice of long duration ETFs. Popular funds include ProShares Ultra 20+ Year Treasury, Vanguard Extended Duration Treasury ETF and iShares 10-20 Year Treasury Bond ETF all popular.
The sleeping bond market giant gave bond investors sleepless nights when it rolled over last year.
It is looking restless again, but this time investors have much less to fear, with prices low and yields high.
A blend of short and long-dated bond funds may be the best way to tackle this complex and often misunderstood giant.

Harvey Jones has been a UK financial journalist for more than 30 years, writing regularly for a host of UK titles including The Times, Sunday Times, The Independent and Financial Times. He is currently the personal finance editor of the Daily Express and Sunday Express, and writes regularly for The Observer and Guardian Unlimited, Motley Fool and Reader’s Digest.

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