I found an interesting 2014 MarketWatch article this week when researching data on bond fund performance during market downturns. It indicates that some types of bonds offer decent protection when the financial markets collapse, other not so much…
For an answer, start with 2008. True, it was an extraordinary year, with the S&P 500 losing 37%, even with dividends reinvested. Still, one reason you own bond funds is to protect you in a year like that—and yet many didn’t.
Emerging-market debt funds plunged 17.6%, high-yield municipal-bond funds fell 25.3% and bank-loan funds tumbled 29.7%. It wasn’t just riskier funds that took a hit. Even short-term bond funds, which invest partly or entirely in corporate bonds, slid 4.2%.
I don’t want to overstate the argument. In a year when the S&P 500 is down 37%, some investors might be comforted to see part of their portfolio drop just 7.9%. But for those who want their safe money to be truly safe, there’s a lesson here: When picking bond funds, avoid even the slightest whiff of “credit risk”—the chance that a company or government might not meet its financial obligations.
This 2016 article from Brett Arends however indicates that if treasury yields are very low when the next crisis hits, treasury bonds may offer less protection than last time…
This time around, though, Treasury bonds have a much harder job pushing the cart up the hill. They’ve already started the year with the kinds of yields we saw at the end of 2008. For instance, the 10-year Treasury bond today pays just 2.17% — almost identical to the 2.13% in December 2008, when everyone was panicking.
And that’s an ominous problem for investors. To provide 2008-style levels of protection, Treasury yields, in effect, will have to halve again — to as little as 1.5% interest on the 30-year bond. Such an event would be extraordinary. It will happen only if investors worldwide embrace the idea of persistent deflation, or falling prices.
If stocks have a terrible year and Treasury bonds don’t step up, an investor with a balanced portfolio may end up losing even more money than in 2008. And if inflation fears were to pick up, bonds could actually fall as well. Investors, cushioned by a gigantic 30-year bull market in stocks and bonds, have forgotten that, in very bad situations, both stocks and bonds can crash at the same time.
It happened in the 1940s and in the 1970s. And if investors are honest, they have to accept the risk that it could happen again.
So, high yield corporate bonds behave like equities, while treasury bonds are more likely to provide protection (or at least fall less) than equities during a crisis.
To me, cash can be more appealing than treasury bonds at the moment, particularly for people who live in a countries where you still get positive real interest payments on deposits.