Why You Own Bonds
In July 2015 I wrote about an unusual occurrence in markets: the fear of bonds seemed to be higher than the fear of stocks.
In the piece, I argued why this fear was irrational despite the likely low returns from a buy-and-hold bond portfolio over the coming years. Given the high valuations of U.S. equities and their overwhelmingly riskier attributes (higher volatility, higher drawdowns) as compared to bonds, the more rational fear would seem to be of equities.
Why was the fear in stocks so low? Quite simply, because they were in the midst of one of the longest runs in history without a negative rolling 6-month return. Many investors were assuming that equities were the new 6-month CD, with little need for bonds, especially when interest rates were expected to rise. (For our research on bonds, click here).
Well, fast forward to today and investors have been reminded once more why they own bonds: because stocks are not exactly risk-free instruments. In fact, they actually go down from time to time as we are seeing this year.
With the S&P 500 down 8% on the year, bonds once again are proving their place in a diversified portfolio, with the Barclays Aggregate Bond Index up close to 1%. If we look back at history, in every down year for the S&P 500 (1977, 1981, 1990, 2000-02, 2008, and 2016 YTD) over the past 40 years, the Barclays Aggregate Bond Index has been positive.
That is not to say that bonds are expected to generate a high return over the coming years. Indeed, I have argued just the opposite (see “bond math and the elephant in the room”) as interest rates remain near historic lows.
But a position in bonds allows investors to withstand equity declines and to hopefully rebalance into equities at lower prices/valuations. For investors close to retirement or in the early withdrawal stages, bonds play a more critical role as the tolerance for a near-term drawdown and higher volatility is significantly lower.
While no one likes to see stocks go down, a position in bonds makes these inevitable declines easier to accept. The start of 2016 (the worst start in history) was a healthy reminder as to why investors still need bonds, even if their future return prospects are diminished.
This writing is for informational purposes only and does not constitute an offer to sell, a solicitation to buy, or a recommendation regarding any securities transaction, or as an offer to provide advisory or other services by Pension Partners, LLC in any jurisdiction in which such offer, solicitation, purchase or sale would be unlawful under the securities laws of such jurisdiction. The information contained in this writing should not be construed as financial or investment advice on any subject matter. Pension Partners, LLC expressly disclaims all liability in respect to actions taken based on any or all of the information on this writing.
CHARLIE BILELLO, CMT
Charlie Bilello is the Director of Research at Pension Partners, LLC, an investment advisor that manages mutual funds and separate accounts. He is the co-author of three award-winning research papers on market anomalies and investing. Mr. Bilello is responsible for strategy development, investment research and communicating the firm’s investment themes and portfolio positioning to clients. Prior to joining Pension Partners, he was the Managing Member of Momentum Global Advisors previously held positions as an Equity and Hedge Fund Analyst at billion dollar alternative investment firms.
Mr. Bilello holds a J.D. and M.B.A. in Finance and Accounting from Fordham University and a B.A. in Economics from Binghamton University. He is a Chartered Market Technician (CMT) and a Member of the Market Technicians Association. Mr. Bilello also holds the Certified Public Accountant (CPA) certificate.
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