Advisors regaining an appreciation for bonds as higher rates settle in

The case for bonds keeps building – or at least the case against them is weaker than it’s been in a long, long time, according to a number of advisors.

Since the start of the year, the yield on the benchmark 10-year Treasury has risen steadily, from just under 4 percent to around 4.4 percent. That’s a long way from the TINA days (short for “There is no alternative”), when a near total lack of yield forced advisors to load up client portfolios with stocks, even in some cases when a client’s age or risk parameters made such an allocation a tad questionable under normal circumstances.  

Much to the delight of savers, the move up in yields has been taking place even as Wall Street’s experts have been assuring investors for months that the Federal Reserve will soon start cutting rates. First they were predicting six cuts, then three, and now, after the strong March jobs report, maybe none this year.

But even as bond owners wait for Fed Chairman Jerome Powell to grab his proverbial ax and start chopping away at rates (sending bond prices higher due to the inverse relationship between yield and price), they are pocketing relatively healthy coupons that they haven't enjoyed on a sustained basis for years.  

Neil Sutherland, portfolio manager at Schroders, says the great news in the fixed-income world is that investors don't need to take a whole lot of risk to get a decent return. In his view, advisors can build an investment-grade portfolio with a simple mix of, for example, securitized assets, Treasuries, and short investment-grade corporates and still get a 6 percent yield.

“We would focus on the higher-quality elements and fixed income at the moment,” Sutherland said. “And I think fixed income looks cheap, not just to its own history but also relative to other asset classes such as equities.”

Hear that, stock jockeys? Bonds are a bargain compared to an S&P 500 selling at a historically high 21 times forward earnings.

“High-quality bonds do look cheap by recent standards,” said Locke Bielefeldt, financial planner at LPL firm Willamette Wealth Partners. “With 10-year Treasury yields near multiyear highs, now is a good time to be a bond investor.”

That said, Bielefeldt warns that not all bonds are the same, arguing that investors are best positioned in bonds that are considered investment grade, which means they have a credit rating of BBB or above.

“We increased our bond positions in most client accounts around November 2023, and are looking for opportunities to buy more bonds when we are putting cash to work,” he said.

David Boniface, advisor and president of LPL firm Legacy Wealth Management, won’t go so far as to call bonds “cheap,” but will readily admit that they are “certainly not as overpriced” as they had been during the incredibly accommodative rate environment seen prior to the tightening cycle that began in the spring of 2022.

“Prior to that time, the primary purpose of high-quality bonds was to serve as behavioral ballast for reducing volatility during equity market turmoil and providing short-term protection required to maintain cash flows,” he said. “Today, they seem much more properly priced and can be used to provide reasonable income flows when allocated properly.”

Boniface adds that while he doesn't expect to dramatically change the general mix of his clients’ allocations, he may lengthen the duration within his fixed--income sleeves as certain areas as the longer-term cash flows offered by those securities become compelling.

Cyrus Amini, chief investment officer at Helium Advisors, says he has increased his fixed-income allocation over the last six months versus equities and plans to continue to do so over the next three to six months as higher coupon payments generate higher yields overall.

“Defaults have increased but the credit market isn’t exhibiting signs of distress yet, which indicates this fixed income cycle has longer to run,” Amini said. “Given the massive run-up in equities, I’d prefer to stay slightly more defensive and move higher up the capital structure. Fixed income, and credit in particular, gives us a way to do that.”

Trent Leyda, CEO at SpirePoint Private Client, says he had been camping out in Treasury bills given their safety of principal and stability of yield. But with the Federal Reserve now likely to lower rates, he sees quality bonds being attractively valued. 

“While there is a chance there is a delay in a rate cut, you still can lock in a nice yield while you wait for the Fed to take action,” Leyda said.

Finally, Brian Glenn, chief investment officer at Premier Path Wealth Partners, doesn't consider bonds overall to be cheap after adjusting for inflation. Furthermore, he sees fixed-income performance becoming overly correlated to that of equities, thereby reducing the diversification benefits bonds once provided.

That said, one area in fixed income where he does see value is mortgage-backed securities.

“Given the current rate environment and low homeowner turnover, the prepayment risk which is inherent in mortgage-backed securities is much lower,” Glenn said. “Coupled with the fact that mortgage-backed securities are yielding close to 2% over Treasuries, this has us believing this is a compelling option for investors.”