Yields for most fixed income investments globally are historically low, and low interest rates are likely to result in muted bond returns over the next decade. Because of the low return expectations, investors may be concerned about allocating to fixed income in multi-asset portfolios.
However, we believe the primary role of bonds in a portfolio is not to produce high returns, but to act as a shock absorber in times of equity market stress. History suggests that high-quality bonds act as ballast for the portfolio in both high and low interest rate environments because of their low correlation with equity.
Amid the low interest rate environment and fears of rising U.S. rates, investors may benefit from non-U.S. fixed income. This can offer diversification because of imperfect correlations of interest rate movements in other countries. Also, when we use Vanguard’s portfolio construction models to build an optimized portfolio, we find that certain high-yielding assets, such as U.S. high-yield corporates and emerging-market bonds, enhance the portfolio’s risk-adjusted return. However, these portfolios should be created based on a solid asset allocation methodology, in particular to manage drawdown risk and at the same time increase expected returns..
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