Why not cash?
Many wary investors are sitting on high levels of cash and cash equivalents, preferring to earn what looks like a decent yield in today’s higher interest rate environment rather than take on additional credit risk. But when does an abundance of caution turn into missed opportunity? How long is too long to wait for a return to “normal”?
Rising Treasury and attractive credit spreads have significantly enhanced income potential
Bond yields are much more compelling with the substantial increase in interest rates over the U.S. Federal Reserve’s current hiking cycle. The Bloomberg U.S. Aggregate Bond Index started 2023 at a yield of 4.7%, the highest level since before the 2008 financial crisis.
Since more than 95% of bond market returns are driven by income rather than price appreciation,1 these higher yields make fixed income investments an important part of a portfolio. And bonds continue to anchor portfolios through their naturally low-to-negative correlation to equities,2 helping build overall total return.
Core fixed income and municipals are solid "cash off the sidelines" candidates
For those looking to increase yield without moving into full risk-on mode, we think it makes sense to explore the broad bond market, including municipals. Figure 2 shows the returns of various asset classes during different rate and inflation environments.
And while the past doesn’t guarantee the future, history suggests that core fixed income and municipals are solid “cash off the sidelines” candidates in periods following rate hikes (when their effects are working through the economy) and when rates are being cut amid economic weakness.
Core fixed income and municipals have historically been solid “cash off the sidelines” candidates in periods following rate hikes.
Staying invested has paid off
Whenever there is market uncertainty, investors may feel compelled to hold cash until the conditions appear more favorable. However, this market timing strategy is not conducive to successful investing. For example, equity investors who missed just the top 10 market days over the last 30 years suffered a -54% loss in market value.
Investors may feel compelled to hold cash, but this market timing strategy is not conducive to successful investing.
1. Bloomberg, L.P., 31 Jan 1976 – 31 May 2023, 99.8% of the annualized total return of the Bloomberg U.S. Aggregate Bond Index was derived from coupon return (as opposed to price appreciation). Index inception is 01 Jan 1976.
2. Morningstar Direct, 10-year period ending 31 May 2023. Correlation between the Bloomberg U.S. Aggregate Index and S&P 500 Index was 0.31
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Important information on risk
All investments carry a certain degree of risk and there is no assurance that an investment will provide positive performance over any period of time. Equity investing involves risk. Investments are also subject to political, currency and regulatory risks. These risks may be magnified in emerging markets. Diversification is a technique to help reduce risk. There is no guarantee that diversification will protect against a loss of income. Investing in municipal bonds involves risks such as interest rate risk, credit risk and market risk, including the possible loss of principal. The value of the portfolio will fluctuate based on the value of the underlying securities. There are special risks associated with investments in high yield bonds, hedging activities and the potential use of leverage. Portfolios that include lower rated municipal bonds, commonly referred to as “high yield” or “junk” bonds, which are considered to be speculative, the credit and investment risk is heightened for the portfolio. Credit ratings are subject to change. AAA, AA, A, and BBB are investment grade ratings; BB, B, CCC/CC/C and D are below-investment grade ratings. Investors should be aware that alternative investments including private equity and private debt are speculative, subject to substantial risks including the risks associated with limited liquidity, the use of leverage, short sales and concentrated investments and may involve complex tax structures and investment strategies. Alternative investments may be illiquid, there may be no liquid secondary market or ready purchasers for such securities, they may not be required to provide periodic pricing or valuation information to investors, there may be delays in distributing tax information to investors, they are not subject to the same regulatory requirements as other types of pooled investment vehicles, and they may be subject to high fees and expenses, which will reduce profits. Alternative investments are not appropriate for all investors and should not constitute an entire investment program. Investors may lose all or substantially all of the capital invested. The historical returns achieved by alternative asset vehicles is not a prediction of future performance or a guarantee of future results, and there can be no assurance that comparable returns will be achieved by any strategy.
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