Bond prices have an inverse relationship to yield: When yield or interest rates increase or decrease, bond prices move in the other direction. By looking at the duration of an asset class, you can potentially estimate how much bond prices might move for every 1% shift in interest rates. Then you could add in the current yield to estimate the potential 12-month return. With the Federal Reserve now on pause, and the market likely anticipating rate cuts in 2024, here is a look at what the potential return might be for specific investment-grade fixed-income asset classes based off current duration and yield levels if the Fed decreased interest rates by 1%.
Over the Long Run, Corporate Debt Has Outperformed Treasuries and Loans
Historically, the additional yield or spread offered by corporate debt has paid off for patient investors. Corporate debt has outperformed two of its more conservative fixed-income counterparts—U.S. Treasuries and mortgage-backed securities—over the past 31 rolling 10-year periods. Investment-grade corporate bonds outpaced those two asset classes 97% of the time, and high-yield outperformed them 90% of the time.
Why Now May Be the Time for Tax-Loss Harvesting
Since most fixed-income funds distribute the majority of their return in the form of monthly distributions, their price return is usually well below the total return. For example, the Bloomberg US Aggregate Bond Index has generated a price return of -2.67% over the trailing 12 months and -11.74% over the past five years. On the other hand, the total return for the index (adding distributions and capital gains) was 0.64% for the trailing 12 months and 0.51% for the past five years. Knowing this, investors may want to take advantage of the current environment and consider tax-loss harvesting their fixed-income losses from what have historically been considered conservative investment options.
After a Hiking Cycle, Longer Duration Has Historically Outperformed Shorter Duration
Historically, intermediate core plus bond funds have significantly outperformed money market and ultra short bond funds in the 12 months following a Federal Reserve hiking cycle, as longer duration bond investors have benefited from higher yields and more attractive relative value. While investors have added $614.1 billion to money market funds so far in 2023, there may be a better investment opportunity with longer duration assets should the Federal Reserve decide to take a pause in the current rate hiking cycle.
How Did Intermediate IG Bonds Perform After the Fed's Last Pause in 2018?
In the 12 months following the Federal Reserve’s last rate hike in December 2018, intermediate investment-grade corporate bonds outperformed the Bloomberg US Aggregate Bond Index by 1.42%. In addition to the higher returns, intermediate investment-grade corporate bonds also generated during this period 28% less volatility than the Bloomberg US Aggregate Bond Index; 57% less max drawdown than the Bloomberg US Aggregate Bond Index; and higher returns in the best and worst quarter than the Bloomberg US Aggregate Bond Index.
Why Duration After a Rate-Hiking Cycle Ends?
Historically, when a Federal Reserve rate-hiking cycle has ended, longer duration spread sectors have materially outperformed more traditional fixed-income and shorter-duration spread sectors in the following 12 months.
What Happened After Fed Last Paused Rate Hikes?
The Federal Reserve has predicted it will raise interest rates once more in 2023. But current market expectations are for a rate pause for the rest of the year and rate cuts to begin in 2024.
Is the Time Right for Corporate Credit?
Historically, when investment-grade corporate bonds, high-yield bonds and bank loans have reached the same price and yield levels as today’s, they’ve generated a 12-month return well above each asset class’s 20-year annualized return.
Yield, Volatility and Bank Loans
Historically, if investors wanted higher levels of yield, they would have to take on higher levels of volatility. But over the past three years, bank loans have had lower levels of volatility than most investment-grade areas of the fixed-income market with higher levels of yield. Bank loans currently offer investors more than two times the yield of the Bloomberg US Aggregate Bond Index, while having delivered 32% less volatility over the past three years.
Yields Across Corporate Credit Have Been Rising
Yields across corporate credit are currently far higher than at the end of 2021. In this environment, the additional credit risk may be worth the additional yield for investors.
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