Investing in Bonds Over Stocks: A 60-40 Portfolio Strategy

Investors are betting on bonds after debt funds in 2022 posted their worst performance on record. This is a good move for investors because bonds are a much safer investment than stocks.

The recent selloff in fixed income has pushed bond yields to their highest levels in more than a decade. This has caught the attention of major fund managers like BlackRock Inc.

Bond experts at BlackRock and Vanguard Group say that high-quality corporate and mortgage bonds are attractive compared with stocks, which could extend their losses from last year if the U.S. economy enters recession.

Individual investors are becoming more bullish on bonds. Retail clients at brokerage firm Interactive Brokers LLC are trading four times as much in bonds now as they were in August. Cash flowing into corporate-bond mutual and exchange-traded funds hit a roughly two-year high in the week ended Jan. 11, according to data from Refinitiv Lipper.

Some investors are recommending a shift from the classic 60-40 portfolio (60% stocks and 40% bonds) to a portfolio with a higher percentage of bonds. BlackRock proposed a portfolio with 35% in stocks and 65% in bonds in a recent report. This portfolio would offer a 6.5% annual yield at current prices, according to the firm's research.

"We're coming out of a tough year for investors, with negative returns in both fixed income and equities," said Gargi Chaudhuri, head of investment strategy for BlackRock's iShares exchange-traded funds business. "Looking ahead to 2023, fixed income is more likely to give you a positive return than equities."

As he approached retirement, Jay Guenard, then 59, began to worry that his equity-heavy portfolio would not provide the stability he would need in retirement. He had worked in the oil and gas industry for most of his career and was used to a more volatile investment landscape. After retiring, he sought to increase his bond allocation and eventually settled on short-term Treasury bills, which he has been rolling over at maturity. He now has about one-third of his retirement portfolio in bonds.

At first, interest rates were relatively low. However, over the past year, rates have increased significantly. This has been beneficial for Mr. Guenard.

Bonds are starting off much better this year than they did last year. The Federal Reserve raised interest rates aggressively in 2022, which increased borrowing costs throughout the economy. This caused investors to sell off bonds that had been issued during the previous decade at lower interest rates. According to data from FactSet, a Bloomberg index of Treasurys, corporate and asset-backed bonds lost 13% last year.

Bond yields and prices have an inverse relationship - when bond prices fall, yields rise. This has been the case recently, with the yield on the bond index doubling to around 5%. This has led many investment firms to recommend portfolios that are heavy on bonds.

BlackRock has been promoting its unorthodox approach to investing through research reports, podcasts and posts on social-media platform LinkedIn. J.P. Morgan Asset Management has been making a similar push, and the bank’s short-term bond ETF has grown by about 30% over the past 12 months to $24 billion. The fund yields 4.5% after expenses and took in $1.5 billion last month, a record monthly inflow, according to FactSet.

The ETF's manager, James McNerny, said that they are seeing increased interest recently and anticipate that to continue. He believes that the yield of the fund is likely to go over 5%.

Investment-grade corporate bond funds saw net inflows of $6.5 billion in the seven days ended Wednesday, the largest inflow since early January. This follows aggregate outflows of around $20 billion in November and December, as investors sold bonds to realize losses and offset their tax bills.

Analysts say that the new investment calculus assumes that growth will slow this year because the Fed will raise rates to between 5% and 5.5%. This would hit corporate earnings and push down stock multiples, extending the equity selloff that began last year.

Some on Wall Street are saying that the central bank will start cutting rates late this year as inflation eases. This would keep the recession shallow and spark an equity-market rebound. Goldman Sachs Group Inc. predicted that the U.S. economy would grow by about 1% this year.

Arvind Narayanan, a corporate-bond portfolio manager at Vanguard, said that 2023 will be a year of growth. However, he added that growth is expected to slow down, making it a challenging year overall.

Bonds may outperform stocks in an economic downturn, but not all debt is a good investment at current prices, according to Mr. Narayanan. He advises avoiding long-term bonds because their yields are unusually low, and the debt of companies with weaker credit ratings because they are more sensitive to economic contractions.

The yield on two-year Treasury bonds is 4.22%, compared with 3.5% for the 10-year bond. This condition, known as an inverted yield curve, suggests that investors are bracing for harder times and interest-rate cuts ahead. The yield on one-year bonds of blue-chip banks like Goldman and Wells Fargo & Co. was about 5% as of last week.

Mortgage-backed bond yields have risen significantly in recent months. The Fed has paused its purchases of the debt and might start selling some of the holdings it accumulated to boost economic activity over the past 13 years. This could have a major impact on the markets and the economy as a whole.

Sam Dunlap, chief investment officer of Angel Oak Capital Advisors, said that his firm is advising clients to put a majority of their portfolios in bonds instead of stocks. Angel Oak Capital Advisors is a $20 billion money manager focusing on mortgage-backed bonds.

Bonds backed by mortgage loans from government-controlled lenders Fannie Mae and Freddie Mac are implicitly guaranteed by the government. The yield on these bonds can range from 6% to 15%, depending on their credit rating.

"That's a return that's similar to what you would see from an investment in stocks or shares," he said.