Given the sudden spike in volatility, investors should not overlook the benefits of a stable government bond exchange traded fund in a diversified bond portfolio.
“We advocate a strategic allocation to government bonds, despite their low potential returns, as a buffer against equity market sell-offs,” BlackRock strategists, led by Richard Turnill, Global Chief Investment Strategist, said in a research note.
Government debt have traditionally provided a buffer against market turns as bond prices would often go up when stock prices fall off and vice versa, offering a negative correlation on average.
Investors witnessed this negative correlation again early last week when North Korea-related geopolitical concerns escalated, reminding investors to diversify equity risk.
“Our analysis shows government bond have provided positive returns during periods of significant equity declines, upholding their diversifying role,” according to BlackRock. “Of the 22 months since 2010 that featured negative U.S. equity returns, bonds notched positive returns in each month in which equities fell 2.5% or more. The one exception: during the taper tantrum.”
While the prospects of higher interest rates out of the Federal Reserve have dampened demand for government debt securities, rates have actually reversed this year from their post-U.S. election highs.
“We do expect interest rates to rise, albeit at a very slow pace as U.S. and eurozone monetary policies gradually normalize,” the strategists added. “We favor stocks overall, but advocate strategic allocations to government bonds including TIPS for diversification purposes.”
Related: Often Overlooked Indirect Cost of ETF Investments
For example, ETF investors can target various U.S. government bonds with varying maturities through options like the iShares 1-3 Year Treasury Bond ETF (NYSEArca: SHY), iShares 7-10 Year Treasury Bond ETF (NYSEArca: IEF) and iShares 20+ Year Treasury Bond ETF (NYSEArca: TLT).
Additionally, something like the iShares TIPS Bond ETF (NYSEArca: TIP) would be a good play on TIPS. TIPS are a type of Treasury security that is indexed to inflation as a way to shield investors from the negative effects of inflation. The securities’ par value rises with inflation as measured by the Consumer Price Index while interest rate remains fixed. TIPS also offer investors another layer of diversification as many aggregate bond funds exclude TIPS from their holdings.
For more information on the fixed-income market, visit our bond ETFs category.