In 2022, aggregate and core bond funds, including active and passive exchange traded funds, delivered some of the worst performances in the category’s history as the Federal Reserve set out upon one of its most aggressive rate-hiking campaigns in years.
While a 180-degree turn hasn’t been notched as of yet, diverse bond strategies are perking up in 2023, and there could be more upside to come as the Fed recently signaled its May interest rate increase could be its last for some time.
Of course, near-term monetary policy is largely reliant on continued declines for the Consumer Price Index (CPI) and the Producer Price Index (PPI), but if inflation cooperates, bonds could catch a bid, potentially renewing investors’ affinity for broad-based fixed income funds. There are other positives to consider, too.
“Further, core bonds have tended to have a low or negative correlation with equities and other risk assets which drives potential diversification benefits. For example, US 10-year Treasuries have a negative beta to growth and positive beta to equity market volatility. In other words, when growth is weak or equity volatility picks up, US 10-year Treasuries tend to perform well, while risk assets weaken,” noted Goldman Sachs Asset Management (GSAM).
Good News: 2022 May Have Been Anomaly
Rare are the instances of stocks and bonds falling in unison on an annual basis, but market participants endured that ominous scenario last year. That dented the diversification case for bonds, but not on a permanent basis. As GSAM noted, last year’s bond market performance might prove to be an exception, not a rule.
“In our view, however, 2022 was a rare occurrence that is not indicative of the long-run potential of balanced portfolios or bonds. Instead, we think the protective power of core bonds has strengthened,” added the asset manager.
Another point for investors to ponder is bond market history, which indicates the higher a yield when an investor buys a bond (or a fund), the shorter the odds are of long-term success.
“Owing to a significant rise since the start of 2022, higher yields are now creating more room for core bonds to potentially buffer declines in cyclical assets during negative growth shocks. This marks a material change to the last cycle when bond yields hovered close to their effective lower bound, with limited room to fall and protect portfolios,” concluded GSAM.
Market participants looking for a core bond ETF with the benefits of active management may want to evaluate the T. Rowe Price QM U.S. Bond ETF (TAGG ). TAGG, which attempts to outpace the widely followed Bloomberg U.S. Aggregate Bond Index, sported a 30-day SEC yield of 4.03% as of April 30.
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