01 Sep 2020
[Endowus AMA] Hi Sam, The interest rate is zero or negative in the US and Europe. How come bonds can provide a positive return in foreseeable when interest can only go higher? Should we just be 100% equity now?
The popular advice is to invest in a combination of stocks and bonds. But the bond yield is the lowest in the last 50 years. Given the money printing happening, the yield can only go up while destroying bond value. I am scared to touch bond now.
Hi thanks for the question. There are a few ways you can make money in bonds even in a negative yield environment and many bond investors have made money in negative yield rates in Europe for example. The reasons are as follows; 1) if negative yields turn further negative then bond prices (which are inversely correlated to yields) will rise and you will have capital gains on your bonds and so you make money. In fact most European bond yields have continued to fall and so bond returns have been positive, 2) Although most government and quasi-sovereigns are negative we still see opportunities in the duration and credi risk spectrum. This means you still have positive yield and good returns possibly in investment grade credit, mortgage backed securities, emerging market bonds, high yield markets, etc. So there are areas of the bond market which gives us positive returns, 3) This is precisely why it is important as an increasingly large portion of the global bond markets are below 1% yield or even negative yield, you need a good active manager of fixed income to manage the funds to get you superior results. That is also why an increasing number of fixed income investors are consistently beating the passive index strategies. Finally this is also the reason why the buy and hold strategy does not work in bonds anymore. If you hold a negative yield bond to maturity then it will obviously not give you returns, so you must actively trade bonds to make sure you can secure higher returns and also take advantages of mispricing in the market - as we saw in March of this year when massive dislocations in the fixed income market gave us tremendous buying opportunity. These are all reasons, we only focus on investing the fixed income portion of our portfolio with active of systematic investors of fixed income like PIMCO or Dimensional who have generated consistently higher than benchmark returns. We continue to believe that bonds and fixed income as an asset class will play an important diversification role. Also we believe that bonds will still be able to generate decent (although not as great as before) returns into the future. Thanks and hope that helps.
I will answer from my perspective! You are right, bond yield have been dropping, especially for quality government bonds. We see that in Germany, Japan, where some of the government bond yield ETFs are dropping.
As Sam mentioned, this makes investing in passive bond funds, which has a very narrow investment mandate (e.g. SG government bonds, or Germany government bonds) less attractive. It is possible for bond fund managers to look at the different bond products out there and make a call that certain bond exposure are more bang for the buck. So do consider holding active bond funds, especially if the total cost of ownership is low.
Also, as long as the investment horizon for the bond is sufficiently long enough, holding bonds will still make sense, even though there may be short term price fluctuations due to interest rates movement.
100% equity can be extremely volatile, you got to ask yourself if you got the risk appetite to do it. I am on a 80:20 portfolio, anyway.
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