We believe we are in a transitory environment that will be increasingly challenging for bonds. With potential rate hikes in the future, it is important to have realistic expectations about bond returns as they are likely to be low in 2022. The image below illustrates the inverse relationship between bond prices and bond yields. Although the bond market is less volatile than the stock market, bonds also fluctuate in terms of price. You can see we have been in a 36-year bull bond market that has brought yields to record lows.
Although bonds typically provide portfolios with a safe haven from market volatility due to their low correlation to stocks, they don’t provide much protection against inflation. In fact, inflation is a major driver of volatility within the bond markets. With the Federal Reserve likely to raise interest rates multiple times in 2022 to combat inflation, investors have been concerned about a potential decline in bond performance. In fact, the Barclay’s Intermediate US Aggregate Bond Index was down -1.54% last year.
For those that have fixed income positions, we have been working diligently to protect your portfolio by allocating to tactical bond strategies that hedge the interest rate exposure with the introduction of iShares Interest Rate Hedged Corporate Bond ETF (Ticker: LQDH). This particular strategy hedges the interest rate risk inherent in bonds by purchasing swaps – ultimately swapping a fixed coupon for a floating coupon. This strategy has an annual yield of 2.37%. We are also, within a tolerance, overweighting equity exposure where appropriate.
Volatility is not going to go away anytime soon so it is important for us to reinforce our investment strategy. Our approach continues to be to build portfolios that help each client meet their financial goals whether it’s a focus on income generation or capital appreciation or both. This means that we like to invest by taking a conservative approach with a focus on high-quality, proven enterprises that pay dividends or buy back shares and have solid balance sheets that are not overleveraged with debt.
Commentary Disclosures: Covington Investment Advisors, Inc. prepared this material for informational purposes only and is not an offer or solicitation to buy or sell. The information provided is for general guidance and is not a personal recommendation for any particular investor or client and does not take into account the financial, investment or other objectives or needs of a particular investor or client. Clients and investors should consider other factors in making their investment decision while taking into account the current market environment.
Covington Investment Advisors, Inc. uses reasonable efforts to obtain information from sources which it believes to be reliable. Any comments and opinions made in this correspondence are subject to change without notice. Past performance is no indication of future results.