Blue HavenBonds

Higher bond yields present investors with options

By August 15, 2022 No Comments

Bond prices have fallen sharply this year, which has been a real pain for fixed income investors. However, with pain comes gain. Yields, which move inversely to prices, are now the highest they’ve been in years. This means that investors finally have some options when it comes to their fixed income portfolio. In addition, cash sitting in the bank can now earn something through extremely low risk investments. We’ll share some of the ETFs we’ve been buying recently that capture different areas of the bond market.

Where bond yields are now

Take a look at where bond yields were at the end of last year compared to where they are now:

These higher yields are widespread, meaning that bonds that are typically safe, and those that are typically risky, have seen a significant rise in yields.

VGSH, an ETF that tracks short-term treasuries with maturities between 1-3 years, is currently yielding 3.10%. At the end of last year, the yield was less than 0.75%. In other words, $10,000 invested in VGSH today can earn $310 over the next 12 months compared to just $75 at the beginning of the year. These types of treasuries are among the safest securities in the world. If you usually keep some cash idle in your portfolio, you may want to consider putting it into VGSH as a cash replacement.

Looking beyond treasuries, corporate bonds are offering their highest yields since prior to the 2008 financial crisis. IGIB is an ETF that tracks investment grade corporate bonds maturing in 5-10 years. IGIB’s current yield is 4.60% compared to 2.50% at the end of last year. IGIB is riskier than VGSH because corporate debt is not as safe as government debt, and it is more sensitive to changes in interest rates since it holds bonds with longer maturities. But that extra risk comes with additional compensation (4.60% yield vs VGSH’s 3.10% yield). In addition, IGIB’s price could provide some capital appreciation as well if interest rates move lower.

Should you “reach” for yield?

The area of the bond market that’s offering the greatest yield right now is high yield, or “junk” bonds. This typically refers to non investment grade corporate debt. A couple ETFs that track this segment of the market are USHY & SHYG. Both of these funds are yielding over 7%. The way these differ from safer bond funds isn’t as much their interest rate sensitivity, but rather how USHY & SHYG will react to sentiment shifts in the economy. If recession fears take hold, for instance, USHY & SHYG would be expected to sell off, even though interest rates may then move lower (and boost other, safer, bond funds). In that way, they function similar to stocks than they do traditional government bonds (though they are still less volatile than stocks).

Because of this, they should not be relied on as traditional ‘diversifiers’ in a portfolio the way higher rated bonds are. But, because of their attractive yields, they still make a lot of sense. One idea could be to pare back some equity exposure and replace it with high yield bonds. For example, if your portfolio is invested 70% in equities and 30% in bonds, you may change that to 65% and 35%, but make the extra 5% in bonds an allocation to high yield bonds through SHYG or USHY. The logic being that a 7% fixed rate may well outperform the S&P 500 over the next 12 months, especially if stocks spend time in a trading range.

Some super safe options

We’ve shared a few different ETF options for the market investor to consider. But attractive yields are also available outside of the market. High yield online saving accounts offered by Discover and Wealthfront are now offering 1.60% and 2.0% yields on cash, far higher than what your traditional big-brand bank is offering. While these are online only accounts, they are FDIC insured. In addition, Discover, Barclays, and Goldman Sacs are all offering 1-5 year CD rates between 2.25-3.25%. CD’s are FDIC insured and will not lose value.

This year has been one for the record books. Stocks and bonds suffered through their worst congruent decline in history. But now, with the dust settling, and stocks having already rebounded from their lows, there’s opportunities in bonds that investors may want to take advantage of. If you’re sitting on cash and wondering what to do? Well, you’ve already lost 8.50% in the last year due to inflation. Now, thanks to higher bond yields, you’ve got some options across the fixed income spectrum, both on the safer side, and riskier side.

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