The events in 2024 that will impact your portfolio
Build robust portfolios to withstand volatility.
Robust portfolios are important so that they can hold up to a variety of different eventualities. There is no way to know for certain what is going to happen next. Rather we can build portfolios that find and protect value over a range of outcomes. Sometimes, it is even a positive. Many investors took advantage of the price dislocation in March of 2020, when there was volatility in the market due to uncertainty about Covid. It can also mean opportunities and taking advantage of opportunities.
After a 22% correction between February 20, 2020 and April 7, 2020, global equity markets rallied tremendously. Despite the massive loss, the Morningstar Global Markets Index managed a 16% return for 2020 in its entirety.
It is impossible to predict if and when there is going to be a pandemic. However, our 2024 Outlook report explores the impact of known risks going into the year and the best way to add robustness to your portfolio.
One of these risks is a contested election in the U.K and U.S. Australia is also going to the polls in 2024 to 2025.
The list has two consistent themes. Most of the risks will result in volatility. However, this does not mean that it could change future return expectations. With this predicted volatility, it could open up buying opportunities if markets react negatively in the short-term.
Secondly, many of these events involve geopolitical risk. The report looks to high-quality bonds to build robustness in portfolios. Geopolitical events don’t always cause equity market sell-offs, but when they do, government bonds, particularly those long in duration provide an offset.
The 2024 Outlook report proclaims that Australian bond exposure looks decent, but our preference is for U.S. Treasuries exposure, with the balance of probable outcomes for yields leaning towards falls.
In this environment, investors do not need to stretch for yield according to the Outlook report. It declares that government bonds in the developed world currently look as attractive as it’s been in at least a decade. This view holds across all durations.
At the same time, corporate bonds also look attractive, but the “spread” between them is on the tight side.
This is best expressed by watching credit spreads, which would usually increase if economic vulnerabilities rise. Yet, spreads haven’t budged, so corporate bonds (both investment grade and high yield) lose relative appeal given the risk of economic deterioration.
For this reason, the analysis leads to favouring government bonds—particularly U.S. Treasuries—on a risk-adjusted basis. Withstanding another serious inflation run, the skew of upside to downside looks favourable. The report also sees appeal in short-term corporate bonds, where positive real yields can be achieved.
If bonds are back, why are bond ETFs performing poorly?
At our recent Morningstar Investment Conference for Individual Investors, we had multiple investment professionals declare that bonds are ‘back’. Similar to the 2024 Outlook report, they found bond exposure attractive.
These declarations were followed by a question from an investor at the conference. For many investors, they choose to have exposure to bonds through collective investment vehicles like ETFs.
‘Given we heard how rapidly bond yields have increased lately, how is it that the Vanguard Bond index ETF (VBND) price is doing poorly (down about 5% over last 6 months) and its distribution is so low.’
Bonds prices move inversely to interest rates. We’ve been in a period where interest rates have gone up which is what so many people were talking about at the conference. This means that while everyone was talking about bond yields being high right now the prices of bonds have fallen as interest rates went up. The reason for this is pretty simple.
If you purchased a bond when interest payments were at 2% you would earn interest payments per year of $20 for $1,000 investment. If interest rates climb to 5% a newly issued bond would pay $50 per year for a $1,000 investment. Since current bonds are yielding 5% nobody would pay $1,000 for a bond yielding 2%. The price has to fall on that bond paying $20 a year to make it yield the same amount.
The issue you run into with an ETF tracking a bond index is that it is a portfolio of bonds. As interest rates go up the price of the ETF will go down. The other issue is that a newly issued bond may yield 5%, but that is not the yield you would get on an ETF because it is a whole portfolio of bonds.
There are some newly issued bonds at 5% and there are older bonds with lower yields. We can see this in the top 10 holdings below. The interest rates on all the bonds are different because some were purchased in the past and some have been purchased more recently. That is why the yield on the ETF will never match current rates.
