Bonds have been in a 35-year bull market. This is nothing new, however, the shift in investor behavior during this expansion is. The devil is in the details.

As the last recession came to a close, interest rates hit rock bottom (rates and price move in opposite directions). Investors, as a result, became more creative in an effort to maintain interest production. It became common practice to reduce quality in an effort to increase interest rates.

During this expansion, the term ‘low for long’ has been heralded as loose monetary policy. It also means low interest rates have dominated the bond market for the last decade.  As lower coupon rates increasingly saturate the market, bond prices become more volatile in response to changes in interest rates.

The combination of these two factors creates an issue for bond investors that incorrectly perceive safety within their bond portfolios.

1) Lower rates serve to increase duration. As duration increases, portfolios become more volatile in response to rate change.

2) Reducing quality in an effort to reach for yield, increases the volatility of a portfolio.

It is important to ensure that the duration and quality in a portfolio are appropriate given your risk tolerance. Given low interest rates, duration can easily creep up adding unexpected volatility.

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Always remember that while this is a week in review, this does not trigger or relate to trading activity on your account with Financial Future Services. Broad diversification across several asset classes with a long-term holding strategy is the best strategy in any market environment.

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