Updating Our Bond Models: Skate to Where the Puck is Going

When asked about his success as a hockey player, Wayne Gretzky is famous for saying, "I skate to where the puck is going, not where it has been."  There have been some significant changes in the bond market.  Interest rates and bond yields have increased significantly, and this has dictated a change to our approach in how we position the bond allocation of your portfolios.  

Watch Now:  Updating our Bond Models: Skate to Where the Puck is Going

Where we were

The massive amounts of government stimulus coming out of the COVID-19 pandemic caused a major increase in inflation.  In 2022, the Federal Reserve tried to aggressively combat the rapidly increasing prices with aggressive increases to the Federal Funds Interest Rate.   The bond market responded in a very unfriendly way.  The Barclay's Capital Aggregate Bond index posted a double-digit decrease in 2022. During this time frame our bond models were positioned to mitigate some of this damage.  While our core holdings weren't immune to the decreases, it did help to mitigate the damage.

Yields and interest rates are now as high as they have been since 2008, and we believe it was time to take those factors into consideration.  As a result, we have made adjustments to take advantage of the higher yields.  

Understanding Bond Basics

Bonds are loans, as a bondholder, you act as the lender.  You loan a company or the government money.  They pay you interest over the life of the loan.  When the loan matures, the principal is returned to you.  In general terms, the interest rate - or coupon - doesn't change over the life of the loan.  

Things get complicated between the time you purchase the bond and when it matures.  Interest rates and yields constantly change, and those outside forces will affect the price of your bond.  The conditions in the market will cause the bond you own to either decrease or increase in value.  If you were to sell that existing bond before it matures, you could lose money.

This is where the term yield comes into play.  Yield is an equation that considers the interest rate, the bond's price, and when it matures.  When you buy a bond, you are normally buying its yield.  The yield is the return you will receive if you hold the bond to maturity. 

Bond funds function a little differently because they are a basket of many different bonds.  There is often turnover in the portfolio from bonds maturing, purchase of new bonds, and sales of existing bonds.  Because of the buying and selling, the math inside of a bond fund isn't as precise. 

When One Goes Up, The Other Goes Down

Bond prices move in the opposite direction of both interest rates and yields. One of the best ways to visualize how the bond market works is to think of a teeter-totter or see-saw from the playground.  On one end you have bond prices.  Yields and interest rates sit on the other side.  Short-term bonds sit near the middle and long-term bonds sit on the far ends of the plank.  When yields go up, as they have recently, the price change of 30-year bonds is far more extreme than a bond maturing in six months.  (There are times when prices of long-term bonds can be as volatile as stocks).

The Foundation of our Bond Model

These concepts form the core principles of how we have constructed our bond models. 

1.  Yields are higher than they have been in 15 years.  We want to take advantage of those opportunities. 
2.  By doing so, we do not have to rely on stocks to generate returns like we did when yields and rates were near zero.
3.  At some point, if yields or interest rates fall, we will be able to benefit from those changing conditions.
4.  We constructed this with risk in mind. We understand the teeter-totter concept well and apply it in this new model. 

We are happy to cover the details of this in greater detail if you wish, just contact your advisor.

What about the mail?

The reallocation of the bond sleeve meant a lot of buys and sells.  Those transactions generated a lot of trade confirmations, which meant many of you got a lot of mail.  For some, this was alarming.  For most it was annoying.  How can you stop it?

The best way is to establish online access with either Schwab or Fidelity.  You can elect to have these trade confirmations sent to you electronically, and if you desire, still get your statements via paper.  If you would like help with this, please reach out to your local office.

Appearing in this video