TALK ABOUT RATES AND BONDS


Most investors are familiar with the bond “seesaw” showing the inverse relationship between bond prices and interest rates – when one rises the other falls. But the reality is much more nuanced. Here we highlight the three important reasons why bonds may be a valuable part of a diversified portfolio across rate environments.

Bond declines have tended to be modest and short-lived

 

Bonds have historically been used for capital preservation, income and growth, and diversification due to their low-to-negative correlations to stocks – essential goals for many investors. Bonds, particularly core bonds, have also been less volatile than stocks. In fact, bond declines have been dramatically less severe than stocks and usually short-lived.

Rates and Bonds chart 1

Rising rates build income

 

Because interest income is the primary driver of bond returns, the ability to reinvest into a gradually rising rate environment has the potential to help build long-term growth. When rates rise, new bonds pay a higher coupon, increasing the income investors receive. By contrast, higher rates can be a headwind for equity investors, as increased borrowing costs weigh on corporate profits.

An increase in a bond portfolio’s income also helps to offset the negative impact on its declining price. Over time, rising income may provide a return advantage for investors.

Rates and Bonds chart 1

Rising rates don’t impact all bonds the same

 

News about the bond market typically focuses on U.S. Treasuries, which tend to be the most sensitive to changing rates. In reality, the bond market is exceedingly diverse and global, and each sector or asset class responds differently to economic and market trends. Some, such as floating rate and high yield bonds, actually have tended to do well in a rising rate environment.

Although a market event may temporarily depress prices across the board, skilled active bond fund managers can diversify a portfolio in an effort to defend against threats to capital while also seeking to capture a range of growth opportunities for their investors.

Rates and Bonds chart 1

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Disclosures

All investments contain risk and may lose value. Investing in the bond market is subject to risks, including market, interest rate, issuer, credit, inflation risk, and liquidity risk. The value of most bonds and bond strategies are impacted by changes in interest rates. Bonds and bond strategies with longer durations tend to be more sensitive and volatile than those with shorter durations; bond prices generally fall as interest rates rise, and the current low interest rate environment increases this risk. Current reductions in bond counterparty capacity may contribute to decreased market liquidity and increased price volatility. Bond investments may be worth more or less than the original cost when redeemed. Equities may decline in value due to both real and perceived general market, economic and industry conditions. Diversification does not ensure against loss. Management risk is the risk that the investment techniques and risk analyses applied by the investment manager will not produce the desired results, and that certain policies or developments may affect the investment techniques available to the manager in connection with managing the strategy. There is no guarantee that these investment strategies will work under all market conditions or are suitable for all investors, and each investor should evaluate their ability to invest long-term, especially during periods of downturn in the market. Investors should consult their investment professional prior to making an investment decision.

This material contains the opinions of the manager and such opinions are subject to change without notice. This material has been distributed for informational purposes only and should not be considered as investment advice or a recommendation of any particular security, strategy or investment product. It is not possible to invest directly in an unmanaged index. Information contained herein has been obtained from sources believed to be reliable, but not guaranteed. No part of this material may be reproduced in any form, or referred to in any other publication, without express written permission. PIMCO is a trademark of Allianz Asset Management of America L.P. in the United States and throughout the world. ©2016, PIMCO.

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