Why should I invest in bonds with interest rates so low?

Interest rates have always been a top concern for many bond investors. The history of pandemics and interest rates over the past seven centuries suggests we can expect an environment of lower interest rates for longer. Some investors are asking: in this very low rate environment, what is the value proposition of bonds? We think there are three key reasons to consider investing in bonds.

1. Bonds still likely to outperform cash

Investors often overlook bonds in favour of cash or term deposits. They think cash is “safe”, while forgetting that “safety” can be costly – holding cash sacrifices return while not reducing overall portfolio risk.

As the chart shows, a portfolio with a 60% allocation to stocks and a 40% allocation to bonds would have achieved a higher return with lower volatility over the long term than a portfolio with 60% stocks/40% cash.

It’s also worth noting that even though bond yields are low, they should still remain attractive relative to cash since cash rates are also likely to remain low given the low level of interest rates.

Bonds still likely to outperform cash

2. Bond still offer a global opportunity set

Not all bonds are government bonds. Bonds have evolved into a USD 100 trillion global market, much larger than the global equity market. It is made up of a variety of fixed income sectors, such as investment grade and high yield corporate bonds, emerging market bonds, and mortgage-backed securities. Bond investors can choose from this broad, global array of sectors, each of which offers a different risk/return profile, with some areas providing a higher return for taking on more risk. Combining a diverse set of bonds in a portfolio can provide the defensive qualities expected from bonds while also generating a return above the cash rate.

Maintaining a diversified bond portfolio can help investors prepare for shifts in the economy and interest rates, allowing them to capture opportunities while also minimizing the risks of overconcentration.

3. Bonds still act as a diversifier

Holding bonds in a portfolio can offer diversification and serve as a hedge against stock market sell-offs. This is because stock and bond prices often move in different directions, which means they generally have a low or negative correlation to stocks, particularly in times of economic uncertainty or deflation.

Bonds and stocks have a negative correlation historically 

Disclosures

Past performance is not a guarantee or a reliable indicator of future results.

This material has been distributed for informational purposes only. Forecasts, estimates and certain information contained herein are based upon proprietary research and should not be considered as investment advice or a recommendation of any particular security, strategy or investment product. Outlook and strategies are subject to change without notice. Statements concerning financial market trends or portfolio strategies are based on current market conditions, which will fluctuate. Information contained herein has been obtained from sources believed to be reliable, but not guaranteed PIMCO as a general matter provides services to qualified institutions, financial intermediaries and institutional investors. Individual investors should contact their own financial professional to determine the most appropriate investment options for their financial situation.

Investing in the bond market is subject to risks, including market, interest rate, issuer, credit, inflation risk, and liquidity risk. The value of most bonds and bond strategies are impacted by changes in interest rates. Bonds and bond strategies with longer durations tend to be more sensitive and volatile than those with shorter durations; bond prices generally fall as interest rates rise, and low interest rate environments increase this risk. Reductions in bond counterparty capacity may contribute to decreased market liquidity and increased price volatility. Bond investments may be worth more or less than the original cost when redeemed. Investing in foreign denominated and/or domiciled securities may involve heightened risk due to currency fluctuations, and economic and political risks, which may be enhanced in emerging markets. Mortgage and asset-backed securities may be sensitive to changes in interest rates, subject to early repayment risk, and their value may fluctuate in response to the market’s perception of issuer creditworthiness; while generally supported by some form of government or private guarantee there is no assurance that private guarantors will meet their obligations. High-yield, lower-rated, securities involve greater risk than higher-rated securities; portfolios that invest in them may be subject to greater levels of credit and liquidity risk than portfolios that do not. Management risk is the risk that the investment techniques and risk analyses applied by PIMCO will not produce the desired results, and that certain policies or developments may affect the investment techniques available to PIMCO in connection with managing the strategy. Diversification does not ensure against loss.

There is no guarantee that these investment strategies will work under all market conditions or are suitable for all investors and each investor should evaluate their ability to invest long-term, especially during periods of downturn in the market. Investors should consult their investment professional prior to making an investment decision.

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