Over the past few years, conservative investors have struggled with holding bonds in their portfolio. Typically viewed as a “safe haven” compared to stocks, bonds have struggled in both bear and bull markets in recent years. Following an aggressive rate hiking campaign to combat rapidly accelerating inflation in 2022, the Bloomberg U.S. Aggregate Bond Index lost 13.01%. With interest rates rising, the negative stock-bond correlation, which was consistent from 2000-2020, saw a reversal. Although 2023 and 2024 saw positive performance, returning 5.5% and 1.25%, respectively, bond investors have been looking elsewhere for better performance. Additionally, with the positive stock-bond correlation seen in recent years, investors have begun looking outside the traditional bond fund that invests in U.S. Treasuries, U.S. government agency mortgage-backed securities and investment grade corporate bonds to mitigate portfolio volatility from stocks.
In the closing quarter of 2024, the Federal Reserve (Fed) indicated that it was expecting 4 rate cuts in 2025 – at the conclusion of its December meeting, the fed indicated that rather than 4 cuts, it was anticipating only 1. This notion was further strengthened by a hotter-than-expected January 2025 Consumer Price Index (CPI) report, which showed inflation had ticked up more than expected. As of this writing (mid-February), the CME FedWatch is predicting the next rate cut to come in September, with a 70.2% probability.
With rate cuts likely to happen much later in the year, if at all, conservative investors are looking to other bond categories for the fixed income portion of their portfolio. One area that has gained much attention is nontraditional bonds. The nontraditional bond category contains funds that pursue strategies divergent in one or more ways from conventional/traditional bond funds. These strategies often have very limited portfolio constraints on exposure to credit, sectors, currency, or interest-rate sensitivity. They may also have exposure to a mix of factors such as absolute return mandates (goals of avoiding losses and producing returns not correlated with the overall bond market), performance benchmarks based on ultra-short-term interest rates (such as T-bills), and the ability to use a broad range of derivatives for market- and security-level positions. Another large subset are self-described "unconstrained" funds, which that have more flexibility to invest tactically across a wide swath of individual sectors, including high-yield and foreign debt, and typically with very large allocations. Funds in the latter group typically have broad freedom to manage interest-rate sensitivity but attempt to tactically manage those exposures to minimize volatility. These funds attempt to minimize volatility by maintaining short or ultra-short duration portfolios, but explicitly court significant credit and foreign bond market risk in order to generate high returns. Funds within this category often will use credit default swaps and other fixed income derivatives to a significant level.
With rate cuts potentially being pushed out to later in the year, or even next year (depending on the path of inflation and the state of the economy), conservative investors might consider exploring options outside of the traditional core bond fund strategy.
This material is intended for informational/educational purposes only and should not be construed as investment advice, a solicitation, or a recommendation to buy or sell any security or investment product.
Please contact your financial professional for more information specific to your situation.
Investments are subject to risk, including the loss of principal. Some investments are not suitable for all investors, and there is no guarantee that any investing goal will be met. Past performance is no
guarantee of future results.
Bonds are subject to availability and market conditions; some have call features that may affect income. Bond prices and yields are inversely related: when the price goes up, the yield goes down, and vice versa. Market risk is a consideration if sold or redeemed prior to maturity.