(November 5, 2013) — Gradual increase in bond rates could lead to high returns in fixed-income portfolios and will be beneficial for long-term investors, according to a report from PIMCO.
The bond markets have endured a tough time since May as rumors of tapering took hold. And confidence in the market hasn’t yet been fully restored, said Jon Short, managing director and head of global wealth management at PIMCO—$43 billion exited the fixed income market into cash and money markets between May and August this year.
PIMCO’s own Total Return Bond fund has suffered record outflows over the last six months—$4.4 billion in October alone according to Morningstar data, and a total of $33.2 billion year-to-date. The manager has even lost its title as the world’s largest bond fund to the Vanguard Total Stock Market Index.
However, Short suggested long-term investors should rejoice in future rising rates and have faith in the “core, quality-oriented securities that anchor many portfolios” and their ability to bounce back.
“Despite the potential for short-term discomfort, rising rates should be welcomed by long-term investors, particularly in this era of historically low yields,” he said.
Interest income, a driver of bond returns, would provide long-term investors with a chance to reinvest in securities with higher coupons, the report found. This strategy would ultimately increase interest income for greater growth potential.
Short argued that there is not much to lose from rising rates, even amid market volatility.
“Even at their most turbulent, bond prices are nowhere near as ‘bubbly’ as stock prices—neither on the upside nor the downside,” he said. They’re rather resilient, he continued—bonds’ sharpest calendar-year price drop was 3% in 1994, while equities sank 38% in 2008 during the financial crisis.
Jumping ship to cash and money markets is not worth it, according to Short’s report. Nominal returns on cash were small at best, with an added potential for negative real returns.
“That’s a steep price to pay for perceived safety,” he said.
PIMCO foresees a “slow and gradual” rise in interest rates as the US Federal Reserve has said it will not raise policy rates until 2016—allowing long-term investors to see higher returns.
“Today’s ‘market of bonds’ is undergoing a sea change, one in which investors will need to de-emphasize duration and tap into other sources of value to boost their portfolios’ return potential,” Short said.
Other sources of value may include premiums from credit quality, yield curve roll down, and currency exposure, the report said.
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