Diversification from Bonds
Given the volatility of U.S. stocks since the beginning of 2025, it is worth noting the diversification benefits of the fixed income portion of our portfolios, which comprises almost 40% of a 37/63 BFA portfolio. For example, on a total return basis (coupons plus price), our recommended intermediate-term U.S. bond fund has gained 4.6% through the first half of 2025.
Bond prices can lose value over short time frames. Bond prices move in the opposite direction of interest rates, so a shift upward in interest rates, such as from the Federal Reserve tightening, can mean a drop in bond prices. However, higher interest rates also mean higher coupons for newer bonds, which bond funds will purchase as the older bonds roll off their books. Bond coupons have historically made up the largest part of bond total returns, so a bond fund’s total return can still be positive even if bond prices have dipped.
Figure 1, courtesy of PIMCO¹, shows the starting yield (or the average yield to maturity) for various types of bond indices as of December 31, 2021 (before the Fed began aggressively raising short-term interest rates) and as of December 31, 2024. While current starting yields are slightly lower since the end of 2024, they remain near decade highs across most fixed income sectors, with yields of investment-grade core U.S. bonds nearly twice as high as the average yield going back to 2010. Higher returns have historically followed higher starting yields, so the outlook is appealing for a variety of bonds, with BFA clients standing to benefit from attractive return potential in fixed-income investments going forward.
Figure 1: Fixed income sector yields (12/31/2021 versus 12/31/2024) –Yields across most fixed income sectors are high vs. recent history
Source: https://taxfoundation.org/research/all/federal/big-beautiful-bill-senate-gop-tax-plan/
Disclosures:
¹As of 31 December 2024. SOURCE: Bloomberg, PIMCO. Index proxies for asset classes displayed are as follows: Agency MBS: Bloomberg MBS Fixed Rate Index, Munis: Bloomberg Municipal Bond Index, HY Munis: Bloomberg HY Muni Bond Index, Core: Bloomberg U.S. Aggregate Index, HY Credit: Bloomberg U.S. Corporate High Yield Index, EM: JPMorgan EMBI Global, IG Credit: Bloomberg US Credit Index; Private Credit: Market estimates for yield.
* Securitized Credit computed as average of CLOs, CMBS, and ABS from JPMorgan and Bloomberg.
** Municipal yields are the taxable equivalent yield, adjusted by the highest marginal tax rate (40.8%). Unadjusted IG Muni index yield is 3.7% with a change of 264bps compared to 12/31/2021 levels, the unadjusted HY Muni Index yield is 5.3% with a change of 254bps compared to 12/31/2021 levels.
¹ The yield to worst is the yield resulting from the most adverse set of circumstances from the investor’s point of view; the lowest of all possible yields.