Understanding Fixed Income Performance

With the increase in stock market volatility we have experienced this year, investors may have wondered why their fixed income positions are showing losses. As a reminder, we view fixed income as a conservative asset class that offsets the risk of the stock portion of diversified portfolios. The primary goal for fixed income is capital preservation, with the secondary goal of generating income. The relationship between stocks and bonds traditionally has a low correlation, meaning they do not move in tandem with one another. This may result in stocks producing positive returns while bonds are negative over a specific time period and vice versa. The benefit of holding fixed income typically exists during periods of stock market stress, such as in 2008, when investment grade fixed income returns were mostly positive while stock markets fell between 40-50%. However, rising interest rates have weighed on fixed income returns this year while stock markets are now positive for the year.

As shown by the green arrow in the chart below, the yield on the 10-year U.S. Government Bond increased approximately 60 basis points for the year (100 basis points = 1%). Rising interest rates cause the price of bonds to decline, which is why the price return on the Barclays Aggregate Bond Index is down 3.3% for the year (shown by red line in chart). However, investors need to consider the higher income produced in their fixed income investments due to rising interest rates. When factoring in the increase in income interest of the Barclays Aggregate Bond Index, the total return is approximately 1% better than the price return (total return is down 2.3% for the year through 5/11/18).

Investors should review both price and total returns when assessing the performance of their fixed income investments. Although rising interest rates have an immediate negative impact on the price of underlying fixed income investments, it is important to understand that the price decline will be recouped over time via higher interest payments. Therefore, we believe fixed income still serves an important role in diversified portfolios to offset the risk of owning stocks despite the negative returns experienced this year. Given our outlook for rising interest rates, we positioned our fixed income to have less interest rate sensitivity by focusing on shorter term bonds. This has resulted in significant outperformance of our fixed income exposure relative to the Barclays Aggregate Bond Index this year, while still offsetting the traditional volatility that comes from stocks.