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Constructing Portfolios for the Fourth Quarter and Beyond: Bonds (Part 2)


Head of SPDR Americas Research

  • Low rates have encouraged risk taking and growth has been supportive, leading credit to outperform rate-sensitive markets
  • Growth is expected to slow and rates are expected to rise but remain low — creating challenges for investors
  • Focusing on specific credit exposures and inflation-protected bonds may help investors reposition portfolios

Today’s complex environment has clients concerned with many variables that could alter the market’s trajectory: Policy normalization, tapering, low rates, fiscal spending impacts, inflationary pressures, expensive valuations, earnings growth stability, market gains concentrated around a few large stocks and the future path of an economy still dealing with the effects of the lingering COVID-19 pandemic. However, when grouped together, the through line of our client conversations centers on these two questions:

  1. How can I continue participating in a policy-supported rally marked by elevated valuations given concerns about the sustainability of future growth?
  2. Where can I source “real” levels of income within bond portfolios that can withstand rising rates?

In this second part of this two-part blog, I will address the second question related to bond portfolio positioning. Check out the first part on equities here.

The Key for Bonds: Get Real for Income

On the bond side of the portfolio, investors must navigate a potentially low return environment for core bonds, given the low starting point on yields and the potential upward bias in interest rates. Sidestepping bonds all together is problematic, however. Their potential diversification benefits could be important to risk mitigation if the rosy outlook above turns out to be more sanguine.

Yet, the issues on the return side are real. Currently, 88% of all investment-grade bonds trade below the market’s expectation for inflation over the next 10 years (10-year breakeven rates are 2.4%), leading to potentially a negative real income level for the largest part of the bond market.1 As shown below, there are very few exceptions in the bond market that can generate a real income level after accounting for inflation expectations.

Bond Yields adjusted for inflation expectations

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1. Bloomberg Finance, L.P. as of September 8, 2021 based on the yields on holdings of the Bloomberg US Aggregate Bond Index less than US 10 Year Breakeven Rate


Bloomberg Barclays US Aggregate Bond Index
A broad-based flagship benchmark that measures the investment grade, US-dollar-denominated, fixed-rate taxable bond market.

Breakeven Rates
The difference in yield between inflation-protected and nominal debt of the same maturity. If the breakeven rate is negative it suggests traders are betting the economy may face deflation in the near future.

The VIX Index is a financial benchmark designed to be an up-to-the-minute market estimate of the expected volatility of the S&P 500® Index, and is calculated by using the midpoint of real-time S&P 500 Index (SPX) option bid/ask quotes.

Originally Posted on September 17, 2021 – Constructing Portfolios for the Fourth Quarter and Beyond: Bonds (Part 2)


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Unless otherwise noted, all data and statistical information were obtained from Bloomberg LP and SSGA as of September 8, 2021. Data in tables have been rounded to whole numbers, except for percentages, which have been rounded to the nearest tenth of a percent.

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Bonds generally present less short-term risk and volatility than stocks, but contain interest rate risk (as interest rates raise, bond prices usually fall); issuer default risk; issuer credit risk; liquidity risk; and inflation risk. These effects are usually pronounced for longer-term securities. Any fixed income security sold or redeemed prior to maturity may be subject to a substantial gain or loss.

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