Interest rates fell sharply in 2020 as the Federal Reserve expanded it’s purchase of government bonds and investor demand for safe and liquid dollar-denominated assets rose.Jan 2020
Short-term interest rates remain close to zero, while the 10-year U.S. Treasury Note yield hovers around 1%. With inflation running about 1.6%, “real” returns on government debt turned negative as the coupon income remains below expected future price increases. It is an odd investment dynamic, but with some $18 trillion of sovereign debt outside the U.S. offering negative absolute yields, U.S. Treasury bonds remain the safe and stable choice for many.
Fortunately, our investment approach has focused on high quality fixed income assets that offer a modest incremental return above government bonds. These assets include corporate bonds at the core
and some peripheral exposure to less liquid sectors such as mortgage bonds and municipal bonds, which we typically own through a diversified fund structure. Though the income component of bond returns remains low, bond prices generally increased during the year as market yields dropped. The net result is a total return in the range of 2-4% on core bonds with a higher return for the more peripheral sectors mentioned above.
Looking ahead, we expect bond markets to remain stable but price appreciation may be lower in the
coming year compared to 2020. With little room for interest rates to fall much further, we expect investors to earn the steady coupon income from fixed income investments but not much more. In this context, bonds offer a safe haven with modest upside; they help to preserve capital and protect principal for patient long-term investors. Owning fixed income also represents a dependable pocket to reach into for liquidity at times of stock market dislocation – think March of last year!