Role of Bonds in a Portfolio – Bonds and a rising interest rate

In an age when data can be churned out for hungry consumers in the blink of an eye (in fact, much faster than it can be studied and the underlying meaning accurately assessed) there is never a shortage of pundits ready to point the way to a new and better ways to invest. With all that hype, it is understandable how you might sometimes feel like abandoning your current investment plan for on recommended by the latest ‘experts’.

In the last quarter of 2013, the bond gurus accepted that it was time to exit bonds and to move to equity assets. The evidence was clear that bonds were ready to collapse since rising interest rate and the end of QE3 would not support bond investments in early 2014.

What actually came to pass was quite different. The first quarter of 2014 was one of the best for US bonds, much better than most equity asset classes. In addition, this last month when all asset classes swooned for about 3-4 weeks, the bond assets of your portfolio remained unchanged or grew. But when have bonds been useful in a real portfolio? I want to draw your attention to the role that bonds played in these specific years between 1997 and 2013: Below, I’ve selected years when large company equity (in developed markets) was down while bonds were up. Note that in each of these year it is the bonds that help a well-diversified portfolio retain its value.

The applicable percentage for US Large Cap, then Non-US Large Cap, then US Bonds, then Global Bonds follow after each listed year from 2000 to 2011:

2000 -9% -14% 11% 9%

2001 -12% -21% 8% 6%

2002 -22% -15% 8% 11%

2007 5% 12% 7% 7%

2008 -37% -41% 5% 1%

2011 2% -12% 8% 9%

This is an example of how bonds play an important role in a diversified portfolio. It is also a reminder of the value that rebalancing plays between asset classes.

In summary, we must not forget the importance of bonds as diversifiers of equity risk in a balanced portfolio, even during low-interest rate periods.

Edi Alvarez, CFP®