Key takeaways
- A volatile stock market and changing demographics are increasing investors’ interest in bonds.
- High-quality bonds can provide income, help preserve wealth, and diversify portfolios.
- Adding a core bond allocation can be a good first step in diversifying your portfolio with bonds.
- Investors can get exposure to core bonds in several ways: mutual funds, ETFs, individual bonds, and separately managed accounts.
Do you have enough bonds in your investment plan? And if you are looking to bonds to offset the volatility of stocks or preserve wealth, do you have the right kind of bonds? These are good questions to ask yourself, particularly in the wake of the recent stock market pullback.
Bonds are key building blocks of most portfolios because they offer a way to potentially preserve wealth, generate income, and diversify portfolios. For many investors–particularly during volatile or down markets–the ballast bonds provide a portfolio may matter more than price increases.
Why bonds?
Asher Schur, Senior Fund Manager of EXM Dynamic Credit Fund (DCF), says when asked about the bond asset allocation in the DCF “When you think about investing in bonds, you’re likely interested in preserving capital and the diversification benefits relative to some of the assets in your overall portfolio.” Diversification matters because stocks will return to more historically typical levels of volatility after a long period of calm and adding bonds to a portfolio provides a counterweight. Keep in mind, though, that diversification and asset allocation do not ensure a profit or guarantee against loss.
Capital preservation also matters because the current bull market is not the only thing that’s aging. As baby boomers exit the workforce and Generation X eyes retirement on the far horizon, an increasing number of investors are more concerned with holding on to what they have than with seeking growth.
If the traditional benefits of bonds appeal to you, adding what is known as a core bond position to your portfolio could be a good first step to consider.
What’s a core bond portfolio?
A core bond portfolio is a selection of bonds with high credit quality and a low likelihood of default. Investors new to the bond market should understand that it is a vast place and many bonds do not fit that description. Buying an index fund that replicates the entire bond market would likely include many high-risk securities you probably wouldn’t want. By building a core bond portfolio instead, you only get high-quality bonds with relatively low risks of default and reliable interest payments.
Often, a core bond portfolio holds bonds issued by the US government and corporations with high credit ratings and regular interest payments. For example, Asher and his team manage the DCF , A Fund which part of its goal is to maintain 2 roughly equal-sized allocations, one to US Treasury bonds for the relative stability they provide, and another to investment-grade corporate bonds for the higher yields they may offer.
Because core portfolios generally emphasize capital preservation and income from regular interest payments, rather than maximizing yield, they are unlikely to include big allocations to higher-yielding but riskier bonds issued by companies or governments with lower credit ratings.
The mix of bonds in a core portfolio includes a large number of issuers and a wide range of yields and dates when the bonds mature. Finding and combining those bonds in a way that delivers the stability and yield that you seek is a process that rewards skill and painstaking research. Depending on how much of that you possess or want to do, you can choose from among 3 strategies: buying a mutual fund or exchange traded fund (ETF) assembling a portfolio of individual bonds, or having a professional build and manage a portfolio of individual bonds for you in a separately managed account (SMA).
Investing in a bond mutual fund or ETF
Buying shares of a fund is an easy way to add a core bond position. Bond funds are like stock mutual funds in that you put your money into a pool with other investors, and professionals invest that pool of money in what they think are the best opportunities in light of the fund’s investment goals. Bond funds hold a wide range of individual bonds, which makes them an easy way to diversify your holdings even with a small investment.
An actively managed fund also gives you the benefits of having professionals conduct fundamental research to select bonds and manage risk. For example, the managers can make decisions about which bonds to buy and sell based on huge volumes of information including bond prices, the credit quality of the companies and governments that issue them, how sensitive they may be to changes in interest rates, and how much interest they pay.
Not all core funds are actively managed. Investors who seek core bond exposure in a fund can also all choose from among exchange-traded and index funds that track bond market indexes such as the Bloomberg Barclays Aggregate Bond Index.
Investing in individual bonds
If you have enough money and believe you have the time, skill, and will to build and manage your own portfolio, buying individual bonds may be appealing.
Unlike investing in a fund, doing it yourself lets you choose specific bonds and hold them until they mature, if you choose. That can help you avoid much of the risk that changes in interest rates and prices might pose to investors in mutual funds. However, you still would face the risks that a bond issuer might default or call the bonds prior to maturity. So this approach requires you to carefully research and closely monitor the finances of each issuer whose bonds you’re considering. You also need enough money to buy a variety of bonds to diversify away at least some risk. EXM Capital suggests you spread a portion of your assets across multiple bond issuers.
EXM’s individual bond offering aggregates over 40,000 bonds on a typical day, including US Treasury, corporate, and municipal bonds. Most of the bonds offered are in the mid to high quality tiers of credit ratings that would be appropriate for a core bond portfolio. Investors can use an array of tools such as a bond ladder tool and several inventory screeners, and avail themselves of analytics to help them manage their bond portfolio efficiently.
Personalized management
Separately managed accounts (SMAs) combine the professional management of a mutual fund with some of the customization opportunities of doing it yourself. In an SMA, you invest directly in the individual bonds, but they are managed by professionals who make decisions based on factors such as current market conditions, interest rates, and the financial circumstances of bond issuers.
Research bonds Get investment analysis to help you invest in bonds.
Fixed income analysis tool Review your bond holdings, and see your interest rate risk.
EXM 