With growth muted, we expect interest rates to rise gradually. Given the low-interest rate environment, some investment managers have invested to varying degrees in lower quality, higher risk bonds in order to boost fund yields. This strategy works well – until it doesn’t.
Given their higher credit risk, high-yield bonds have a very high correlation to equities of about +0.7. While assuming equity-like risk in bond portfolios in prior years has been an effective strategy, it does not hold up well in times of equity market volatility, as we saw during the fourth quarter of 2015 through the first six weeks of 2016.
Investors should beware of this practice and avoid investing in core bond strategies that have exhibited scope creep. Not all core bond funds are created equal and those that are managed to enhance yield by taking equity-like risk will probably not protect investors against equity market declines.
If investors expect their bond allocations to provide good diversification from equity losses, then the funds they invest in should contain little high-yield bond exposure. Assuming too much equity-like risk in bond portfolios can result in the fixed income component declining alongside one’s equity investments, when it should be tempering volatility and providing capital preservation.
Investors should seek a balance of bond funds, with high-yield funds occupying a smaller position. For the largest allocations, consider well-diversified, quality-oriented core bond funds like The Bond Fund of America®, which focuses on achieving a high level of income and capital preservation.
Investors should carefully consider investment objectives, risks, charges and expenses. This and other important information is contained in the fund prospectuses and summary prospectuses, which can be obtained from a financial professional and should be read carefully before investing.
Investments are not FDIC-insured, nor are they deposits of or guaranteed by a bank or any other entity, so they may lose value. This material is intended for use by financial professionals or in conjunction with the advice of a financial professional.
Figures shown are past results and are not predictive of results in future periods. Current and future results may be lower or higher than those shown. Share prices and returns will vary, so investors may lose money. Investing for short periods makes losses more likely. View expense ratios and returns.
The return of principal for bond funds and for funds with significant underlying bond holdings is not guaranteed. Fund shares are subject to the same interest rate, inflation and credit risks associated with the underlying bond holdings. High-yield bonds are subject to greater fluctuations in value and risk of loss of income and principal than investment-grade bonds. Investing in bonds issued outside the U.S. may be subject to additional risks. They include currency fluctuations, political and social instability, differing securities regulations and accounting standards, higher transaction costs, possible changes in taxation, illiquidity and price volatility. These risks may be heightened in connection with investments in developing countries. Refer to the fund prospectus and the Risk Factors section of this report for more information on these and other risks associated with investing in the fund.
Investment results assume all distributions are reinvested and reflect applicable fees and expenses.
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