Bonds have had a challenging year, and we have received questions about whether or not we should extend our average bond maturity/duration now that yields have risen. We have considered this internally, but at this time we don’t anticipate any changes.
- Stocks and bonds are more correlated than ever, so if we ever experience another year like 2022 when stocks and bonds are down meaningfully in the same year, we would want to have the protection of a relatively short/low duration bond portfolio. If you’re unfamiliar with the term “duration,” it essentially means the average amount of time until you get your payments for a bond. For example, bonds with longer maturity have longer duration than bonds with shorter maturities, and bonds with higher coupon payments have lower duration than bonds of similar maturity with lower coupon payments.
- We are benefitting from higher yields already. Yield calculations can be confusing and there are many different ways to look at yield, but everything comes back to the distributions. Every month (in the case of our funds) a dividend is paid out representing the interest on the bonds in the portfolio. Regardless of when you bought in, the price of the fund, or whether you have a loss or gain, those distributions represent the income on your bonds. These distributions are starting to creep up in some of our funds already, and this trend is likely to continue as long as yields remain elevated. This means that even without trading in our current portfolio for longer funds, we’re still getting these higher yields.
- In fact, the yield curve is inverted currently, meaning that longer bonds actually yield less than shorter duration bonds. While there’s more opportunity for price appreciation if you buy longer bonds, there’s also more risk if there is a downturn in the bond market, and you simply aren’t getting paid to go out long on the yield curve right now. The highest yields are in the 2-3 year range and bonds 10 years and beyond yield less.
Looking at history, longer bonds almost always outperform shorter duration bonds, so you might be surprised that we don’t insist on long duration in our bond portfolios. As you can see from the discussion above, we have a very different approach to managing risk in our bond portfolio than on the equity side. In fact, we believe our bond portfolio is the security that allows for the risk we take in the stock market. It’s possible that longer bonds could dramatically outperform shorter bonds in the near term, but it’s also possible the worst isn’t over for bonds. We believe our short to intermediate average maturity gives us the best possible combination of yield and volatility dampening for an unknown future, and don’t anticipate any changes at this time.
