Why You Need to Own Bonds

Why You Need to Own Bonds

Written by: Grayson Blazek

When one thinks about portfolio diversification, bonds, in addition to US and International equities should be evaluated.
 

An investor may be tempted to overlook bonds altogether given that investing in equities tends to lead to higher overall returns (see Exhibit 1 below). So why include bonds in your investment portfolio? The answer lies in reducing the volatility of your portfolio, providing for short-term cash needs and helping you sleep better at night.

Annualized Returns

Diversification and reduced volatility
 

The purpose of allocating a portion on your portfolio to bonds is to reduce overall volatility. There is risk in allocating a large portion of your portfolio towards equities when markets are at high levels. By including bonds in your asset allocation, your overall portfolio risk is reduced given that bonds are not as highly correlated with equity returns and tend to act as a diversifier during market downturns (see exhibit 2 below). Additionally, by allocating a portion of your portfolio to bonds, this allow you to have funds in your portfolio available when stock prices are more attractive to increase your stock allocation.

Bond Downside Protection

Today’s Environment and the opportunities it presents
 

For the past thirty years, we have been in a falling interest rate environment (see Exhibit 3 below). From the all-time highs in the early 80’s, interest rates had fallen to near zero in recent years. This led to outstanding performance in the bond markets. Like equities, bull and bear markets tend to be cyclical. The difference being that while cycles in equity markets tend to last a few years, cycles in bond markets tend to last a few decades as rates can remain low for longer than people expect. For example, it took approximately 19 years for interest rates to rise from just below 2% in 1941 to 4.75% in the early 1960s.

US Treasury Rates

Investing in a rising interest rate environment
 

Given that bond prices tend to fall when interest rates are on the rise, is now a good time to invest in bonds or should they be avoided? While in the short-term bond prices will decline, rising interest rates are a good thing for bond investors so long as their bond portfolio is adequately prepared. The further out on the duration scale you go; the more bond prices will be affected by interest rate moves. The duration of a bond is the approximate measure of a bond’s price sensitivity to changes in interest rates and is measured in years.

In rising interest rate environments positioning your portfolio towards bonds with shorter maturities, risk for loss of principal will be reduced. The reason for this is that as bonds mature, the principal is available to be reinvested at higher rates. So, while over short time periods, increasing rates can result in negative performance, over time, the benefit of higher interest rates compounds and results in longer term positive performance.

Risks of the Bond Market Index
 

So why not just invest directly into a bond index fund? As outlined in Exhibit 4 below, the duration of the index has extended over the last few years. Keeping in mind that the longer the duration the more sensitive bonds are to rising interest rates, the relative ‘safety’ that bonds typically bring to a portfolio has been diminished.

Why You Should Own Bonds-Financial Symmetry, Inc.

Since the financial crisis in 2008, the Aggregate Bond Index’s underlying composition, which was heavily weighted towards mortgage and other asset backed securities in 2008, has transitioned to US Treasury bonds in recent years. Traditionally, asset backed securities have a shorter duration than the longer-dated US treasuries which is one of the causes of the duration extension of the index.

Expected Bond Returns
 

Starting bond yields are highly correlated to future bond returns so with the bond market index yield in the low 2% range, index returns should align to that. How do you get higher returns? We don’t recommend reaching for return in the bond market as it should act as a stabilizer when the equity markets decline. That said, the bond market index composition is based on the percentage of bonds outstanding (see Exhibit 5 below). By buying what is a better value and not the highest weight may help increase your return over the index.

Why You Should Own Bonds-Financial Symmetry, Inc.

Lower Yields
 

Additionally, corporations are taking advantage of the current environment and locking in low interest rates over longer periods of time. With bonds locked in at lower interest rates, coupons have decreased from over 5% in 2008 to just over 3% (see Exhibit 6 below). Together, these factors have culminated to fundamentally change the composition of the Aggregate Bond Index, and have resulted in an increase in the index’s risk level.

Why You Should Own Bonds-Financial Symmetry, Inc.

Conclusion
 

Finally, high quality bonds offer investors something of an emotional hedge against poor behavior. Not every investor is willing or able to have their entire portfolio in the stock market. There’s no use in trying to implement a risky portfolio strategy if periods of poor performance are going to cause you to not stick with it. Bonds can help by providing stability in the event of a stock market sell-off.

Even if bonds were to fall in a down stock market, it wouldn’t be nearly as severe. In this respect, bonds can act as a source of funds for either rebalancing into stocks at lower prices or for selling for cash flow needs. Ultimately, they provide the stability investors crave to alleviate the stress that volatile stock markets can cause.

Chad Smith
Advisor
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Chad has spent the last fifteen years helping people discover how they can spend more time on things they enjoy.  He is a Certified Financial Planner (CFP®) an ... Click for full bio

China's Push Toward Excellence Delivers a Global Robotics Investment Opportunity

China's Push Toward Excellence Delivers a Global Robotics Investment Opportunity

Written by: Jeremie Capron

China is on a mission to change its reputation from a manufacturer of cheap, mass-produced goods to a world leader in high quality manufacturing. If that surprises you, you’re not the only one.


For decades, China has been synonymous with the word cheap. But times are changing, and much of that change is reliant on the adoption of robotics, automation, and artificial intelligence, or RAAI (pronounced “ray”). For investors, this shift is driving a major opportunity to capture growth and returns rooted in China’s rapidly increasing demand for RAAI technologies.

You may have heard of ‘Made in China 2025,’ the strategy announced in 2015 by the central government aimed at remaking its industrial sector into a global leader in high-technology products and advanced manufacturing techniques. Unlike some public relations announcements, this one is much more than just a marketing tagline. Heavily subsidized by the Chinese government, the program is focused on generating major investments in automated manufacturing processes, also referred to as Industry 4.0 technologies, in an effort to drive a massive transformation across every sector of manufacturing. The program aims to overhaul the infrastructure of China’s manufacturing industry by not only driving down costs, but also—and perhaps most importantly—by improving the quality of everything it manufactures, from textiles to automobiles to electronic components.

Already, China has become what is arguably the most exciting robotics market in the world. The numbers speak for themselves. In 2016 alone, more than 87,000 robots were sold in the country, representing a year-over-year increase of 27%, according to the International Federation of Robotics. Last month’s World Robot Conference 2017 in Beijing brought together nearly 300 artificial intelligence (AI) specialists and representatives of over 150 robotics enterprises, making it one of the world’s largest robotics-focused conference in the world to date. That’s quite a transition for a country that wasn’t even on the map in the area of robotics only a decade ago.

As impressive as that may be, what’s even more exciting for anyone with an eye on the robotics industry is the fact that this growth represents only a tiny fraction of the potential for robotics penetration across China’s manufacturing facilities—and for investors in the companies that are delivering or are poised to deliver on the promise of RAAI-driven manufacturing advancements.

Despite its commitment to leverage the power of robotics, automation and AI to meet its aggressive ‘Made in China 2025’ goals, at the moment China has only 1 robot in place for every 250 manufacturing workers. Compare that to countries like Germany and Japan, where manufacturers utilize an average of one robot for every 30 human workers. Even if China were simply trying to catch up to other countries’ use of robotics, those numbers would signal immense near-term growth. But China is on a mission to do much more than achieve the status quo. The result? According to a recent report by the International Federation of Robotics (IFR), in 2019 as much as 40% of the worldwide market volume of industrial robots could be sold in China alone.

To understand how the country can support such grand growth, just take a look at where and why robotics is being applied today. While the automotive sector has historically been the largest buyer of robots, China’s strategy reaches far and wide to include a wide variety of future-oriented manufacturing processes and industries.

Related: Smooth Tomorrow's Market Volatility With a Smart Approach to Robotics & AI

Electronics is a key example. In fact, the electrical and electronics industry surpassed the automotive industry as the top buyer of robotics in 2016, with sales up 75% to almost 30,000 units. Assemblers such as Foxconn rely on thousands of workers to assemble today’s new iPhones. Until recently, the assembly of these highly delicate components required a level of human dexterity that robots simply could not match, as well as human vision to help ensure accuracy and quality. But recent advancements in robotics are changing all that. Industrial robots already have the ability to handle many of the miniature components in today’s smart phones. Very soon, these robots are expected to have the skills to bolster the human workforce, significantly increasing manufacturing capacity. Newer, more dexterous industrial robots are expected to significantly reduce human error during the assembly process of even the most fragile components, including the recently announced OLED (organic light-emitting diode) screens that Samsung and Apple introduced on their latest mobile devices including the iPhone X. Advancements in computer vision are transforming how critical quality checks are performed on these and many other electronic devices. All of these innovations are coming together at just the right time for a country that is striving to create the world’s most advanced manufacturing climate.

Clearly, China’s trajectory in the area of RAAI is in hyper drive. For investors who are seeking a tool to leverage this opportunity in an intelligent and perhaps unexpected way, the ROBO Global Robotics & Automation Index may help. The ROBO Index already offers a vast exposure to China’s potential growth due to the depth and breadth of the robotics and automation supply chain. As China continues to improve its manufacturing processes to meet its 2025 initiative, every supplier across China’s far-reaching supply chains will benefit. Wherever they are located, suppliers of RAAI-related components—reduction gears, sensors, linear motion systems, controllers, and so much more—are bracing for spikes in demand as China pushes to turn its dream into a reality.

Today, around 13% of the revenues generated by the ROBO Global Index members are driven by China’s investments in robotics and automation. Tomorrow? It’s hard to say. But one thing is for certain: China’s commitment to improving the quality and cost-efficiency of its manufacturing facilities is showing no signs of slowing down—and its reliance on robotics, automation, and artificial intelligence is vital to its success.

Want all the details? Download the ROBO Global Investment Report - Summer Brings Best ROBO Earnings in Six Years or visit us here.

ROBO Global
Robotics and AI
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ROBO Global LLC is the creator of the ROBO Global® Robotics and Automation Index series, which provides comprehensive, transparent and diversified benchmarks representing the ... Click for full bio