Despite the low yields and lack of future catalysts to bolster the space, corporate credit and government bonds exchange traded funds still have a place as a core diversifier in investor portfolios.
Many investors are worried about the prospects of the fixed-income space after yields fell over the past three decades and the Federal Reserve’s shifting stance on its loose monetary policy. However, bonds will continue to provide investors with a source of stability during times of duress, Financial Times reports.
Investors can stick with heavy positions in fixed-income, the asset class with the best risk-adjusted returns over the past decade. Investors can also try shift over to equities and floating rate fixed-income to avoid rate risks. On the other hand, people can hedge with a diversified allocation of both bonds and stocks.
A heavy position in fixed-income may be out of the question as it is unlikely investors will enjoy the same level of risk-adjusted returns experienced over the past. Over the past five years, U.S. government bonds that mature in five to seven years showed an annualized return of 4.4%, a volatility of 4.5% and a return-risk ratio of about 1.0% while investment grade credit returned 7.5% at a 5.2% volatility and a ratio of more than 1.4.
Related bond ETFs, iShares 7-10 Year Treasury Bond ETF (NYSEArca: IEF) and iShares iBoxx $ Investment Grade Corporate Bond ETF (NYSEArca: LQD), show similar returns, up an average annualized 5.7% and 7.6%, respectively. [Considering Core Intermediate Bond ETFs]
However, to produce similar risk-adjusted returns in the next five years, five-year Treasury yields would need to dip to below minus 1%, or credit spreads between Treasuries and corporate debt would have to break record lows.