27 November 2023

Global bonds are experiencing a remarkable surge, reaching levels unseen since the 2008 financial crisis.

In global sovereign and corporate debt measurements, Bloomberg found impressive average returns in November—the most substantial monthly gain since the December 2008 depths of the Great Recession. According to Bloomberg, corporate bond average yields by themselves were at their highest since 2009.

This resurgence is propelled by growing speculation that the U.S. Federal Reserve, along with other global central banks, has concluded its interest rate hikes and is poised to initiate cuts in the coming year.¹

So, with all this activity around this asset class, what options do investors have when it comes to bonds? And how do they factor into a well-balanced investment portfolio?

Types of Bonds

There are five main types of bonds in the United States: Treasury, agency, municipal, corporate, and savings bonds.

U.S. Treasury bonds (a category that encompasses bills, notes, and bonds) are issued by the Treasury Department and are of paramount importance in determining rates for long-term, fixed-rate bonds through auctions that fund federal government operations. Renowned for their safety, these bonds are guaranteed by the U.S. government, attracting widespread ownership from institutional investors, corporations, and sovereign wealth funds.

Agency bonds, on the other hand, are issued by quasi-governmental agencies such as Fannie Mae and Freddie Mac and are backed by the federal government’s guarantee.

Municipal bonds issued by cities present a tax-free investment option, albeit with slightly lower interest rates and a slightly elevated risk compared to federal government bonds.

Corporate bonds are issued by a wide variety of companies and introduce an increased risk-return dynamic compared to government bonds. Corporate bonds come in three subtypes: junk bonds (or high-yield bonds with a high chance of default), preferred stocks (functioning like bonds, offering fixed dividends), and certificates of deposit (bank-issued, ensuring a fixed rate of return).

Finally, savings bonds are issued by the Treasury Department with a focus on individual investors and offering affordability.²

Bond Prices and Yields

The most important thing to understand about bond prices and yields is the inverse relationship between bond prices and interest rates.

Simply put, bond prices fall when interest rates rise, and conversely, bond prices go up when interest rates rise.³ This inverse relationship results from bonds having a fixed interest rate based on their time of purchase (their ‘coupon rate’), which requires pricing in secondary markets to adjust based on the prevailing interest rates when existing bonds are bought or sold. Higher interest rates make newly issued bonds more enticing, prompting a price reduction for older bonds with lower rates in order to attract investors.⁴

To optimize returns, it’s advisable to consider purchasing bonds during high interest rate periods. During such intervals, the bond’s yield is elevated, leading to a more substantial investment return compared to periods of lower rates.⁵

Factors Influencing Bond Performance

In addition to interest rates, three other factors significantly impact bond performance: market conditions, credit ratings, and the age of the bond.

Market dynamics play a crucial role in bond performance, as shifts in the broader market impact investor behaviour. During stock market upswings, for example, bond prices experience a downturn as investors tend to pivot towards equities and demand for bonds declines. Conversely, market corrections usually prompt a return to bonds and their perceived safety.

Credit ratings, assigned by agencies like Moody’s and Standard & Poor’s, serve as barometers of an issuer’s payment reliability. A downgrade in credit rating renders a bond less attractive, likely leading to a decline in its price.

And the age of a bond in relation to its maturity date also plays a role. As a bond approaches maturity, its price converges towards par, with the bondholder receiving the total face value at maturity. This interplay between age, market conditions, and ratings shapes the performance of bonds and shows how their valuation can be multifaceted.⁶

The Yin and Yang of Equities and Bonds

So, if stock prices are one factor that affects bond performance, how should we understand the relationship between stocks and bonds?

The chief difference between stocks and bonds is the difference between equity and debt.

Equity, in the form of stock offerings, is a common and popular way for companies to raise large amounts of cash that can be used to scale their business. In return for this infusion of cash, investors receive stocks that provide them with a small percentage of ownership in a company and the opportunity to benefit from the future success of that company through dividends and an appreciation of the stock’s valuation. Stocks and equity represent liquid financial assets that can quickly and easily be converted into cash.

Conversely, bonds are an issuance of debt which a government or corporation agrees to pay back in a set amount of time and with a set amount of interest. While bonds thus have value, unlike stock they do not confer any ownership stake in the company. However, because the issuer guarantees both the repayment of the full principle plus interest, bonds are generally considered a more stable investment than stocks, whose value can fluctuate higher or lower than the initial purchase price.⁷

The Benefits of Bonds in a Balanced Portfolio

While the potential for higher returns with equities might be tempting for most investors, one should not overlook the importance of bonds in building a balanced portfolio despite their fixed returns.

The chief benefits of bonds in a portfolio include:

• Income generation: Bonds provide regular income and enable investors to patiently build toward significant financial goals.
• Capital preservation: Bonds ensure capital safety and secure returns, serving as a reliable asset—think of them as a safety net for your portfolio.
• Hedge against economic slowdown: Bonds act as a buffer for a portfolio during periods of market turbulence, offering stability amid the volatility of stocks. As an example, in Q1 2020, the S&P 500 dropped 20% amid concerns over the COVID-19 pandemic. At the same time, long-term U.S. Treasury bonds gained ~10%.
• Portfolio diversification: Multiple asset types performing differently reduces overall portfolio risk. Bonds have low correlations to stocks and real estate, offering an easy way to enhance the diversification of a portfolio.⁸

ETF Options for Bonds

If you’re looking for an opportunity to diversify your portfolio with fixed-income holdings like bonds, one option is investing in fixed-income ETFs.

Evolve Enhanced Yield Bond Fund (BOND ETF) provides investors with a low-cost fixed income solution that seeks to deliver attractive monthly income and long-term capital appreciation. To enhance yield, as well as mitigate risk and reduce volatility, BOND will initially employ an active covered call option writing program on 50% of the portfolio.

For more information on Evolve Enhanced Yield Bond Fund (BOND ETF), explore fund details here.

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Sources

1. Reynolds, G., “Global Bonds Head for Best Month Since 2008 Financial Crisis,” Bloomberg, November 28, 2023; https://www.bloomberg.com/news/articles/2023-11-29/global-bonds-surge-toward-best-month-since-2008-financial-crisis
2. Amadeo, K., “Types of Bonds and Which Are the Safest,” The Balance, October 5, 2021; https://www.thebalancemoney.com/what-are-the-different-types-of-bonds-3305600
3. Lioudis, N., “Inverse Relation Between Interest Rates and Bond Prices,” Investopedia, March 28, 2023; https://www.investopedia.com/ask/answers/why-interest-rates-have-inverse-relationship-bond-prices/
4. Mittal, V., “What Is the Inverse Relationship Between Bond Price and Bond Yield?,” Yubi, November 22, 2022; https://www.go-yubi.com/blog/bond-prices-bond-yields/
5. Lioudis, N., “Inverse Relation Between Interest Rates and Bond Prices,” Investopedia, March 28, 2023; https://www.investopedia.com/ask/answers/why-interest-rates-have-inverse-relationship-bond-prices/
6. “What affects the price and performance of bonds?,” PIMCO Canada, n.d.; https://www.pimco.ca/en-ca/marketintelligence/bond-basics/what-impacts-the-price-and-performance-of-bonds/
7. Davis, C., “Bonds vs. Stocks: A Beginner’s Guide,” NerdWallet, August 29, 2023; https://www.nerdwallet.com/article/investing/stocks-vs-bonds
8. “The role of bonds in a balanced portfolio,” Markets.com, November 27, 2023; https://www.markets.com/education-centre/role-of-bonds/

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