Bond-fund managers have a clear view of the near future and expect the economic and political environment to improve. Despite the current volatility in world markets, they have put their money where their mouth is and allocated capital to the few promising opportunities that have presented themselves since the global financial crisis of 2008. In doing so, they have set themselves apart from the many retail investors who have missed the boat and are now trying to get in on the action as the market recovers.
What Are They Buying?
A look at the top holdings of the leading bond-fund managers shows a diverse range of investments. As global central banks attempt to normalize interest rates and the economic outlook improves, the appeal of defensive holding—that is, buying bonds whose prices move inversely with interest rates—increases. This has resulted in a significant increase in demand for such securities as investors seek the safety of government bonds with low yields and become less interested in speculative ventures. The shift to more conservative investment is apparent in the lower returns shown by most bond-fund managers in the final year of 2018 as rising rates and inflation dampened the appeal of defensive bonds.
Why Are They Sticking With Bonds?
The fear of missing out (FoMO) is a phenomenon that affects millennials and can be traced back to the financial crisis of 2008. After years of following the market’s whims, they are finally seeing the benefit of playing it safe with bonds and are looking for the security of putting their money in a known entity (government bonds) and knowing that the value won’t drop due to fluctuating world markets. As a result, the top managers of the smart bond funds that we looked at have seen a large increase in demand for short-term high-quality bonds over the past year, with a significant portion of their holdings being sold off in advance of the year’s end to be replaced by higher-yielding instruments.
Is This The New Norm?
Over the past year, the performance of the smart bond funds has been lackluster, offering fewer rewards to their shareholders compared with traditional bond funds. While volatility has decreased, the level of risk has increased as the funds have had to become more selective in their asset allocation. With little or no positive surprise in store, it’s probably time to re-evaluate your long-term investment strategy and consider putting your money into a high-performing stock market fund instead. Alternatively, you could also look to take some profits from the strong performance of the past year, reduce your investment exposure and wait for a better return in the future. We have looked at the top-rated smart bond funds, but be sure to check out the full list of 2018’s top performers at https://www.investorsanalogies.com/top-rated-smart-bond-funds/. It’s worth noting, however, that the best-performing bond funds aren’t necessarily the most expensive ones—which is why we recommend using an index fund to build your portfolio—as they tend to outperform their rivals based on their strict investment criteria.
What About The Mid-Term?
Many investors will be looking to take some advantage of the current low volatility in world markets and want to sit back and hold onto their investments for the long term. Government bonds offer the safest of safe havens and are extremely appealing to those seeking the traditional route of putting their money to work for them. The appeal of the safe harbor is amplified by the increasing level of protection offered by sovereign wealth funds and the development of the “gold-plus” strategy, which combines the price stability of gold with the income generating potential of government bonds. This places these types of investments at the heart of many long-term investment strategies.
The world of mid-term bond investing is complicated and largely dictated by market psychology. From a contrarian point of view, it’s important to note that while prices of long-term government bonds have declined in the medium term, this has largely come about because of large-scale government paper sales, which have sought to offset the rising cost of wars, increasing health care expenses and the burgeoning federal budget. As a result, there is no guarantee that the price of long-term government bonds will continue to decline and, in fact, evidence suggests that it could rise in the near future based on current market expectations. In such a case, it would be unwise to engage in active management by selling off assets in the middle of a long-term bond’s horizon—unless, of course, you’re anticipating a rise in interest rates.
For the majority of investors, though, the appeal of government bonds is clear. With increasing demands from baby boomers seeking the safe haven that their savings offer, they can expect to see more institutions following the lead of the top-performing smart bond managers and turning to government bonds for the safety and stability they provide.