Is it the right time to invest in bonds?

It is the best of times and the worst of times to be a bond investor. For those who have been investing loyally in bonds for years, it is the worst of times. And for anyone currently entering the bond market, it is arguably the best of times.

Here's why. In the wake of the financial crisis, the central banks kept the policy rate close to zero for years. This may have helped to get the economy back on track, but it certainly didn't help bonds. Bonds are normally virtually synonymous with predictable returns, but now low interest rates have resulted in very low or even negative returns for bonds. Anyone who invested in bonds between around 2010 and 2020 saw their purchasing power shrink because the returns were not or barely enough to beat inflation. And the real bad news was yet to come …

From bad to better

In 2022, the central banks decided to raise the policy rate to slow down rising inflation. In addition, they pushed these rate hikes through very quickly. Investors who held bonds at the time suddenly felt exposed: not only was the return barely worthwhile, the value of their bonds also plummeted (-30% and -40% were no exception in 2022). After all, who would still want to buy existing bonds if new bonds were issued that offer a much higher return?

As bondholders took a beating, an opportunity arose for new investors. They could and still can enter a market in which higher returns can be achieved, something that had not been possible in years. Whereas in mid-2020, US government bonds with a 10-year maturity yielded barely 0.6%, now they yield more than 4% (as at 2024 March). In mid-2020, 10-year German government bonds had a negative return of -0.5%, compared to around 2.4% today.

The same type of rises can be seen in corporate bonds. High-quality corporate bonds (investment grade) from the eurozone are currently yielding around 4%, compared to less than 0.5% three years ago. Global high-yield corporate bonds are now generating a return of around 8%, even though they returned less than 0.5% three years ago (source: S&P Global and Bloomberg).

Sunny outlook

Bonds are once again at the top of the menu for investors today in all segments. Let's illustrate this with a simple comparison. Imagine that you receive an annual return of 4.5% on a bond that matures in ten years. If you compare this with a return of 0.2% a few years ago, the difference is huge. If you invested 10,000 euros in a bond with a return of 0.2% per year and you held on to it until maturity, you would receive 10,202 euros after ten years. However, if the bond yielded 4.5%, you would receive 15,530 euros.

Bond yields therefore look quite tempting after the drought of the 2010s. Higher interest rates also protect against inflation, at least on the assumption that it will continue to cool in the near future. Moreover, we are most likely approaching the peak of the interest rate cycle. Any further depreciation due to interest rate hikes therefore seems limited. The best time to invest in bonds is when interest rate expectations peak, so that yields are at their highest and any drop in expectations can give their value a boost.

Caution: not completely risk-free

While equities generally come with a higher risk (and therefore a higher potential return), bonds are much lower on the risk scale. But despite attractive yields and a current positive outlook, bonds are obviously also not without risk. In addition to the (perpetual?) the question regarding whether governments (and some companies) can sustain their high levels of debt, inflation is persisting in various regions and there is always a risk that central banks will take action to temper rising prices again. In addition, investors should be aware of the risk of default, which is reflected in the prices. This will increase if the economy deteriorates, and it iwll have an impact on corporate earnings. The high-yield bond segment in particular can be susceptible to this. Higher interest rates are also a problem for companies as they increase their debt burden, and companies refinancing their debt at the current market rates are only adding to the pressure.

Window of opportunity

The past six months have already offered interesting opportunities to those looking to bolster their portfolios with bonds. Today, this window of opportunity is still open, but it will not last forever. Several central banks will very probably announce further interest rate cuts this year. The faster the markets anticipate falling policy rates, the faster the higher yields will disappear. It may therefore be advisable to consolidate the current attractive long-term returns in your portfolio now.

How to get started

Diversification is the cornerstone of any investment strategy. This applies to both equities and bonds. This investment category is often considered less risky than equities, but this does not detract from the fact that diversifying your investments is crucial. This means investing across a broad spectrum of issuers and credit ratings and varying the maturities of your bonds.

Building your own bond portfolio can be complex. The selection of individual bonds requires an in-depth examination of the issuer’s financial health, the bond's maturity and the interest rate offered. Although choosing bonds can be an interesting process, there is a price tag attached to broad diversification by investing in many different bonds. A tracker or actively managed bond fund is a simpler alternative. They enable you to invest in a wide range of bonds at the same time.

Trackers, also referred to as an exchange-traded funds (ETFs), track the performance of a bond index and are a passive but effective way to invest in bonds. The advantages of these funds are that their low management costs and the fact that they are traded on the stock exchange on a daily basis. The other option is actively managed bond funds, with which fund managers try to beat the market by choosing bonds they believe will outperform the market.

Investing in bonds, bond trackers or bond funds?

• Log in to Keytradebank.be on your laptop or desktop
• Click on Advanced at the top of the screen, then ask to search by instrument name, symbol or ISIN
• Tick Bonds, Tracker and/or Fund
• Search by bond name or the terms corporate bond, bonds, yield, government.