Why you shouldn't dismiss fixed income despite low returns

It's easy to dismiss fixed income these days, with the cash rate sitting at 0.10%. But don't dismiss it too quickly. It can still serve a vital role in your portfolio.

Money reached out to Kenneth Leech, chief investment officer of Western Asset, to find out why.

Diversification

Achieving true diversification requires more than just having different asset classes in your portfolio. You want assets that are negatively correlated with one another. So if one goes down, that loss will be muted by another asset performing as well as it had been or better.

"The only asset that demonstrates a consistent low to negative correlation to risk assets over time is fixed-income," says Leech.

"Morningstar data show that over a five-year period, the US Aggregate Bond Index has a near zero correlation to the S&P 500 and other major equity indexes, and it has a very low correlation to hedge fund and private equity indexes."

US treasuries, a fixed income staple, continue to show a negative relation to major equity, hedge fund and private equity indices over a five-year period.

"Negative correlation implies that if risk assets fall fixed-income assets will rise."

Stability

Sure, fixed income isn't generating a lot of return these days. But it still provides an efficient return relative to the risk you're taking investing in it.

"Fixed-income indices have relatively low volatility (measured as standard deviation), which means that investors are taking relatively low risk for the returns they get from bonds and other fixed-income assets," says Leech.

At the end of 2020, the standard deviation of the Bloomberg Barclays US Aggregate Bond Index was 3.2% and the risk to return ratio was 1.4. By contrast, the standard deviation of the S&P 500 Index was 15.3% and the risk/return ratio was 1.

Protect against downturns

As we've seen, downturns can come from anywhere, and fixed income provides a safe refuge during these times.

During last year's crash, the Dow Jones fell 37% in 40 days.

Fixed income investors, however, were insulated from much of the brunt.

Between 9 January and 9 March 2020, US 30-year Treasuries netted 32% as their yield fell to a low of 0.99%."

"For investors in the decumulation phase, the risk mitigation benefit of fixed-income comes with the added advantage of a valuable source of income."

Get stories like this in our newsletters.