Staying invested in bonds
05 May 2017 | Markets and Economy
When yields rise, fixed income investors typically focus on the threat of capital loss. Are there other factors to consider? Rachel Baxter interviews Paul Malloy, head of fixed income, Vanguard Europe.
Rachel Baxter (moderator): Staying invested in bonds. When yields are likely to rise, fixed income investors typically focus on the threat of capital loss. This is an understandable response, but are there other factors to consider. My name is Rachel Baxter. I have with me Paul Malloy, Head of fixed income at Vanguard Europe.
Paul, I think it is reasonable to expect bond yields to rise in the coming months and years, so what do you have to say to investors that face a loss in the value of their investments?
Paul Malloy (head of fixed income, Vanguard Europe): It is true that as yields go up, you will see a decline in value of the fixed income securities, but as important as the rise in yields, is the pace at which the rise happens. We expect rises in rates to be gradual over a longer period of time, so that should temper some of the capital loss.
Rachel Baxter: And how will that look in terms of total returns?
Paul Malloy: That will actually make total returns positive. You will be able to reinvest the coupon payments and the maturities of the bonds at higher yields over time and be able to recover any of the capital losses associated with the gradual rise in yields.
Rachel Baxter: And what is the impact on the diversification benefits of holding bonds in the wider investment portfolio?
Paul Malloy: So the outright level of yields and the diversification benefits of bonds are widely independent of one another. You will be able to observe over time that as risk assets, such as equities selloff, the value of bonds actually increase and when the value of bonds decrease, it is typically associated with a large rise in risk assets and the rise in risk assets of equities will offset any of the capital losses associated with fixed income.
Rachel Baxter: Bond yields are likely to rise, but the rise will be gradual and limited. As cash flows are reinvested, total returns should remain positive for most investors in the longer term and bonds, of course, offer powerful diversification benefits in a wider portfolio.
Paul Malloy, thank you very much.
Paul Malloy: Thank you.
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