The Potential Benefits of Bonds’ Boring Investment StyleSheaff Briefs Editor
When Oppenheimer Managing Director Leo Dierckman asserts that bonds should most definitely continue to be included in investment portfolios—even when interest rates are expected to rise—he means what he says. Dierckman believes that bonds serve as the backbone of both individual and institutional portfolios, and help offset the risks of equity and alternative investment holdings.
While the portfolio manager admits that interest rates tend to rise when the economy is improving, which can render lower-paying existing bonds less attractive, those same improving economic forces can improve corporate credit, and thus reduce the credit risk inherent in bond portfolios. That improved credit climate may mean that corporate bond investors can do better in an environment of slowly rising interest rates than in a sustained low rate climate.
How does that work? Duration is one of the two relevant measures of risk in a bond. The length of time until a bond’s final return of principal to the investor is what dictates the risk. That’s because the longer the money is out of our hands and tied up in a previously issued bond holdings, the less responsive we can be in terms of being able to buy newer, higher-rate bonds using that money. But the second factor, credit quality, is also important, with high quality income securities serving to reduce risk.
The investment style Oppenheimer uses to manage Sheaff Brock bond portfolios seeks to avoid the risk and volatility of derivatives, instead managing duration with a combination of investment grade and high yield corporate bonds along with Treasuries. As Dierckman explained to our SheaffBriefs Editor, “I believe the combination of asset classes can outperform strictly investment grade bond portfolios—and with less volatility.”
Daisy Maxey, writing in the Wall Street Journal two years ago, made a simple case to bond fund investors worried about rising rates. “As the bonds in funds’ portfolios mature, managers will reinvest in newer issues with higher interest rates, and investors will benefit from increased income.”
The expectation for the remainder of 2016 and for next year is moderate GDP growth. “For 2017, our panel sees GDP growth at 2.1%,” stated the FocusEconomics website. Dierckman sees those and similar forecasts as support that the Oppenheimer “boring backbone” bond management style is on the right track.
Should bonds continue to be included in investment portfolios? When he addresses Sheaff Brock investors at our special November Knowledge Builder webinar on the dynamic relationship between interest rates and your bond portfolio, Leo Dierckman’s answer to that question is likely to be “Most definitely”!