ETF Trends
ETF Trends

A recent article in Barron’s titled “A New Approach to Bonds” has generated a number of calls to SSGA’s team. While the article made a lot of good points, I think a quick reading of the piece left some strongly negative impressions with a number of readers, and I’d like to address those in this post.

The Barron’s piece was subtitled “Bond funds tend to hold their value—unless rates are rising. Is it time to dump yours?” For many readers, the immediate takeaways could be that bonds in general are a poor investment as we enter a rising rate environment, and bond funds are a particularly bad way to invest in bonds in that environment. Here’s where I found the article potentially misleading:

  1. “A New Approach to Bonds”: Much of the text in the article treats bond funds as a monolithic asset class, which I believe is a decidedly traditional approach. There is virtually no mention of non-traditional fixed income funds that may help investors navigate a rising rate environment, such as senior loans or floating rate securities. As I detailed in an earlier blog post, Why It’s Time to Disaggregate the Agg, the evolving way to view fixed income is as a collection of asset classes that can play different roles as the rate environment changes. While investors may want to underweight some types of bonds in the current environment, others can serve fixed income investors well as rates rise. Admittedly there was some mention in the article of using different types of bonds for different purposes, most notably municipal bonds. But I’m concerned that the takeaway for the casual reader was that all bond funds may be a poor investment at this time, as expressed by the article’s dramatic subhead, “Bond funds tend to hold their value—unless rates are rising. Is it time to dump yours?” I think this does investors a disservice, by not exposing them to the wide range of options and solutions available within fixed income.
  2. Reasons to own bonds: The Barron’s piece laments that “There was a time when bonds could do it all—provide stability, income, and capital appreciation. Those days are over.” In reality, those “do it all” days, if they ever existed, were all but over in 2008, when the Fed pushed short-term rates to near zero and then placed downward pressure on rates with quantitative easing for five years. Investors who depended on bonds for income have been searching for yield ever since, a point the article does not touch upon. For those investors, who comprise a large proportion of fixed income holders, rising yields for both individual bonds and bond funds can’t come soon enough. Higher yields will translate into a higher level of income generation. As some retirement investors like to say, the income is for the bond investor and the net asset value (NAV) is for their heirs.
  3. Individual bonds vs. bond funds: A key point in the article is that “Investors who own individual bonds and hold them to maturity are insulated, of course [from rising rates]: barring a default, they’ll still get their principal and interest.” I would say that insulation is more perception than fact. Both market value of an individual bond and the NAV of a bond fund will likely lose value as rates rise. The loss is just less apparent for the individual bond unless the investor checks the market price, which is not always easy to do. In fact, this is one of the reason that bond ETFs have grown as they offer efficiency and transparency and an over-the-counter, opaque market.

In fairness, I think the Barron’s piece raised some good points about the role of bonds in a portfolio, even in a rising rate environment—such as providing income and serving as a counterbalance to stock investments. But I disagree with the views in the headline and first parts of the article, which leaves a strong, yet not entirely accurate impression on the reader and may be the entire takeaway for many investors. I invite you to read the Barron’s article for yourself and let us know what you think in the comments section below.

Definitions

Senior Loans

Senior loans are obligations of sub-investment grade rated companies (rated below Baa3 by Moody’s, BBB- by Standard & Poor’s). The interest rate paid on senior loans typically floats with major short term interest rates. Senior loans are typically backed by collateral such as company assets.

Floating Rate Securities

Floating rate securities are obligations of companies typically rated investment grade (rated above Baa3 by Moody’s, BBB- by Standard & Poor’s). The interest rate paid on floating rate securities typically floats with major short-term interest rates.

David Mazza is a Vice President of State Street Global Advisors and the Head of Research for SSGA’s ETF and mutual fund businesses.