Bonds are recovering in 2023 after one of their worst years ever as the asset class reinstated as an effective hedge for equities. Case in point: Investors sought safety in Treasury bonds during the recent banking crisis. That was not the story last year, when rising interest rates affected the value of Treasury bonds and were the culprit of the stock bear market. The double drop has shaken confidence in the 60/40 portfolio, a strategy that refers to holding 60% equity and the remaining 40% in equity bonds that have long been seen as a cornerstone of the portfolio. foundation of prudent investment. It challenges the long-held belief that asset diversification drives returns, on the assumption that stocks and bonds often move in opposite directions, and has led some in the investment world to claim this strategy. dead”. “Bonds are acting like bonds again,” said Gina Bolvin, president of Bolvin Wealth Management Group. “While inflation levels remain elevated and the Fed continues to raise interest rates, high-quality bonds are recovering and providing a cushion for equity risk during this stock market downturn. Year after year bad last year, it’s good to see bonds re-assuming their role as a diversifier in a diversified asset allocation stock market.” TLT’s iShares 20-year or older Treasury bond The iShares 20-year and older Treasury bond ETF (TLT) highlights that recovery, with the fund rising 7.3% in 2023 after falling 32.8% in last. And BlackRock 60/40 Target Allocation Fund Institutional Shares (BIGPX), an ETF that tracks returns on a 60/40 portfolio, is up 3.4% year-to-date in 2023 after falling 17.9% year-on-year. last. Those gains come when both chart assets return. The S&P 500 is up 3.4% year-to-date, offsetting a 19.4% drop in 2022, its biggest annual decline since the Great Recession. The Morningstar US Core Bond Index has added 3.4% this year after sliding nearly 13% — the worst year on record — in 2022. Following last week’s decline, Treasury yields The US 2-year and 10-year terms are still near historic highs. over a decade. “It looks like a cycle of high yields may have begun, but bonds still have value and yields that investors rarely see,” said Ross Mayfield, investment strategy analyst at Baird. since the financial crisis”. ‘The timing’s right’ Money market funds have seen strong outflows in recent weeks as investors rush to the corners of the fixed-income market that are considered the highest quality following. when the bank closes. Money market funds hold short-term liquid securities such as Treasury bills. “For those investors who may have shied away from bonds because of their performance in 2022 or because of previous years of low yields, this is not the case,” said Sara Devereux, global head of fixed income. this may be the right time to consider adding bonds to the portfolio.” at Vanguard. Furthermore, because bonds tend to rebound during recessions when prime rates fall, Devereux said she recommends focusing on high-quality fixed income including U.S. Treasury bonds, equities, and stocks. mortgage-backed securities and municipal bonds. Corporate bonds have the opportunity to profit, but investors need to scan for credit risk in addition to a potential recession. Chris Fasciano, portfolio manager at Commonwealth Financial Network, says investors can look to diversify their credit quality towards bonds in a 60/40 portfolio. income. According to Sam Millette, Commonwealth fixed-income strategist, bond yields remain attractive as the first quarter of 2023 wraps up. He noted that the 3.9% yield on the 10-year US Treasuries is nearly double the previous 12-month dividend yield of 1.73% on the S&P 500. US10Y US2Y ALL mountain of Treasuries 2 U.S. five- and 10-year bonds He also recommends focusing on higher-quality bonds, adding that current high yields mean investors no longer have to over-allocate to quality credit. lower, which has a higher default risk. Looking ahead, Millette said fixed-income investors could see more upside through the end of 2023. “The combination of yields remains high and upside potential in a time of market volatility. certainly makes a relatively compelling case for fixed income for the rest of 2023,” he said. Bolvin said initial returns can help predict future return on investment, and current performance suggests “the runway for solid returns in fixed income is just beginning.” She said the outlook for high-quality bonds after last year’s performance was the best she’s seen in a decade. To add or not to add? The uptrend in the price of bonds raises the question: Should investors continue to invest more? Commonwealth Financial has not changed its allocation since the start of the year. But Bolvin retracted his stock overweight in his tactical model, citing improved payback prospects for bonds. She reallocated 2% to the bond, bringing her equity ownership down to 63%. For fixed income, she also recommends sticking with bonds with AAA or AA ratings, saying investors should look for risk in stocks rather than bonds with ratings. lower. Bolvin also upgraded preferred shares when they were dumped during the banking crisis. Bolvin said she would consider a 2% to 5% allocation to preferred stock in a typical balanced portfolio. She also said investors who suspect rate cuts will soon, or greatly, should increase their holdings of quality bonds as the market plunges. Bolvin, who predicted earlier this year that a 60/40 portfolio would be revived, said a diversified portfolio did a better job of helping investors mitigate volatility in 2023 — a portion of the bond. “While the returns on stocks and bonds have been positive so far this year, the fact that stocks and bonds have largely performed well at different times has made the ride smoother for us,” Bolvin said. the investors”. “That’s the view of a 60/40 portfolio. After all the calls for a 60/40 death last year, we think the prospect of a diversified portfolio is the best. for years because of improved earnings prospects for fixed income.”