Figure 1 – Declining interest rates supported Core Fixed Income returns (1/1/1980–12/31/2020)
Figure 2 – Portfolios with greater stock exposure lost more during the Covid selloff
|Portfolio Stock/Bond Mix||Covid Selloff (2/16/20–3/21/20)|
|60% S&P 500 / 40% Morningstar US Fund Intermediate Core Bond||
|60% S&P 500 / 40% Morningstar US Fund Intermediate Core Plus Bond||
|80% S&P 500 / 20% Morningstar US Fund Intermediate Core Bond||
|80% S&P 500 / 20% Morningstar US Fund Intermediate Core Plus Bond||
Adjusting the sources of risk
This increased downside potential matters because investors tend to be risk averse and reactionary. When a portfolio exhibits downside risk beyond their tolerance level, investors may choose to abandon their holdings and move to cash. This is generally the worst course of action, as it undermines long-term performance and reduces the probability of reaching future goals.
But instead of reducing the allocation to bonds, it may make sense to change the sources of bond risk. Rather than buying a handful of core bond or core plus bond managers, investors may have to get more tactical and specific with their fixed income positions. One choice is to allocate to specific fixed income sectors, as opposed to a broad mandate manager. This can help to control duration (the sensitivity of a bond’s price to changes in interest rates) or the type of credit exposure. Another choice is to use non-traditional strategies like option-writing or market neutral funds as fixed income alternatives that have low correlations to interest rates and/or credit.
The most important thing to consider when choosing how to allocate positions within a portfolio’s fixed income sleeve is the overall risk of the sleeve, and to make sure it still behaves like traditional fixed income risk once allocations have been decided. If investors start using equities or equity alternatives in place of fixed income, they will introduce equity risk, which has the potential to increase the overall risk of the portfolio to something beyond their risk tolerance.
S&P 500® Index is a widely recognized measure of US stock market performance. It is an unmanaged index of 500 common stocks chosen for market size, liquidity, and industry group representation, among other factors. It also measures the performance of the large-cap segment of the US equities market.
Past performance is no guarantee of future results.
The views and opinions expressed may change based on market and other conditions. This material is provided for informational purposes only and should not be construed as investment advice. There can be no assurance that developments will transpire as forecasted. Actual results may vary.
This material is provided for informational purposes only and should not be construed as investment advice. There is no guarantee that objectives stated will be achieved. All securities are subject to risk, including possible loss of principal. Please read the risks associated with each investment prior to investing.