Still a place for bonds in your portfolio

Yields drop if rates rise, but they’re considered safe place to put money

Investors face a number of vexing financial questions this year, but perhaps none trickier than whether they have any reason to hold bonds.

According to many portfolio managers, these once risk-free investment vehicles are almost virtually guaranteed to lose money in 2013.

The reason is simple: interest rates, at historical lows in many countries, face pretty decent odds of going up some time in the next 12 months. In fact, a recent CNN survey of money managers noted that 23 of 32 expect borrowing charges to start rising some time into 2014 at the latest.

As interest rates rise, bond yields drop. So bonds seem, at first blush, like the one investment you should not hold this year.

Think twice, however, before you decide to drop corporate or government fixed-income vehicles from your holdings altogether.

“It’s still a place to park your money,” says Avery Shenfeld, chief economist at CIBC World Markets Inc.

As the eurozone deals with its economic crisis, the U.S. administration hammers out permanent agreements on the “fiscal cliff” and the government’s debt ceiling, and China tries to slow its economy without crashing, there is enough global financial risk to make some bonds — in some durations — a reasonable place for investors’ cash.

“It is still an important asset class (for individuals),” says Andrew Dedousis, senior wealth adviser with the Guelph office of Ontario-based Meridian Credit Union.

But these fixed-income assets actually posted good investment gains for the past few years.

In 2012, for example, bonds returned, on a five-year basis, 6.5 per cent compared to the Toronto Stock Exchange, which posted a gain of just 0.69 per cent, and the S&P 500, which moved the profit meter at 1.2 per cent.

“Bonds have performed quite well for the past five years,” Dedousis says.

As any investment segment can-

“Bonds have performed quite well for the past five years.” ANDREW DEDOUSIS, SENIOR WEALTH ADVISER AT MERIDIAN CREDIT UNION

not post good returns forever, it makes sense to believe the bond bull market might be ready to turn into a bear in the not-too-distant future. But before you hit the “sell” button on fixed-income instruments, first consider the positives of holding bonds. For one thing, at least in Canada, stocks are not expected to post particularly juicy returns in 2013. Forecastchart.com, a website that tracks various financial and economic forecasts, estimates the TSX will gain 4.7 per cent in 2013, less than the amount bonds were returning in 2012. And, while most experts expect interest rates to rise, there is little consensus on when. The U.S. Federal Reserve, for instance, has expressed a desire to keep interest rates low until unemployment drops below 6.5 per cent, a situation that will not occur, according to CIBC World Markets, until after 2014. Equally compelling, inflation, usually a catalyst for raising borrowing charges, is still low. For example, Canada’s annualized CPI for November 2012 was 0.8 per cent. Still, if investors are uncertain about the timing of higher interest rates, they could just buy short-duration bonds, whether government or corporate issues, Shenfeld says. “If you go into the short end of the market, you aren’t affected much by a rate increase.” With that strategy, an investor can diversify between equities and fixed-income investments and still minimize his or her exposure to rising rates. The particularly irksome question in 2013 — whether to invest in fixedincome instruments at all — may have yielded to the fundamental proposition that bonds have always been low-risk holdings with decent returns. In the end, bonds remain a useful part of anyone’s portfolio — whether someone eyeing retirement or an investment fund.