Coronavirus Impact on Bond Market
Although most of the attention has been on the stock market, the bond market was equally shaken to its core during the Coronavirus crisis; the action is highly unusual.
In most market environments, the bond market trades with little volatility. If there’s uncertainty in the air, investors typically race toward what’s considered a relative safe haven: bonds.
That didn’t happen this month, however; stocks and bonds were tightly correlated. When the stock market fell, so too did the bond market—prices dropped while interest rates spiked.
We can see that correlation by comparing the 10-year Treasury to the Volatility index (VIX). Over the last month the charts are in near lockstep. As volatility spiked, rates on the 10-year increased. Now, as volatility retreats from its peak in the wake of coordinated action by the central bank and Washington, rates on the 10 year have come down.
Those most whipsawed by this unusual correlation are investors in bond funds or ETFs, regardless of type. Long- or short-term, high- or low-quality, there was nowhere to hide.
Check out the following charts for Vanguard Short-Term Investment-Grade Fund followed by iShares Corporate Bond Fund, respectively:
Challenges abound for managers of these vehicles and others like them. The biggest challenge over the last month? Dealing with redemptions.
Given the huge amount of uncertainty caused by the Coronavirus pandemic, many bond fund or bond ETF investors redeemed shares in a race to raise cash amidst the chaos.
Managers dealing with redemptions have no choice but to sell positions and fulfill their customer requests for cash. That might explain why we didn’t see the buying of bonds when stocks sold off…
Whatever the cause, the action spotlights a weakness attached to owning a bond fund or ETF—the value of the fund or ETF can (and does) change. We saw exactly that over the last month, and this time the price change was significant.
That’s not a good situation for those that need cash for specific expenses, usually known well in advance thanks to proper planning.
Imagine owning one of these short-term bond funds (that, by definition, are supposed to offer capital preservation) because you want to finance a wedding this summer. Instead of getting 100% of your principal on the date needed, you (an investor in a bond fund or ETF) must sell at the net asset value even if that net asset value is now lower, as was the case here in March.
That simply doesn’t happen when you own a customized portfolio of bonds that pay full principal upon maturity (unless there is an underlying issue with credit).
While it’s true that the value of every asset class can and does change with fluctuations in the market, we prefer holding a bond till maturity as doing so essentially negates those changes in price.
At Nicollet Investment Management, our use of customized portfolios allowed us to be much nimbler and more flexible during this crisis.
If a client had cash available that was earmarked for bond investment when rates spiked, we bought bonds. Probably the same bonds being sold by the very fund managers discussed above. Looking forward, bond fund managers that sold bonds in the middle of the month may now be forced to buy bonds as rates fall.
The Federal Reserve indicated it will buy bonds in a form of quantitative easing that appears to be unlimited.
While that sends rates lower now, market participants are braced for a flood of supply thanks to new issuance by the Treasury. Issuance needed to pay the checks being mailed from the $2 trillion stimulus package.
It’s hard to know what will transpire next.
One of the few things we can count on is volatility, and volatility bodes well for those using customized bond portfolios in their personal financial plans.
To learn more about how customized bond portfolios can help you reach your goals and objectives, give us a call for a free consultation.