Are Bonds A Good Investment During A Recession?

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Bond investments were highly favoured in 2022, as the US Federal Reserve (Fed) raised interest rates from 0-0.25% to 4.25–4.50% in less than a year to tame runaway inflation. This benefited investors, who were able to lock-in attractive yields on new issuances across all bond sectors compared to other asset classes like equities or cryptocurrencies.

While inflation has been slowing down in recent months, it continues to remain persistently high at around 7.1% (as of November 2022). This is higher than the 2% target set by the Fed, which projects to further hike rates to above 5% in 2023. According to a Bloomberg Poll, 7 out 10 economists believe a global recession is unavoidable this year as interest rates rise and the global economy slows.

Taking reference from this, bond investments are likely to remain a key asset class for investors, whether or not we avoid a recession. Depending on the volatility of the interest rates set by the Fed, bond investments may offer better investment opportunities compared with equities or staying in cash.

Read Also: Beginner’s Guide To The Different Types Of Bond Investments In Singapore

What Is An Economic Recession?

There is no official definition of a recession. But it is generally understood that two consecutive quarters of negative growth in a country’s real gross domestic product (GDP) would amount to a technical recession.

There are also deep implications when a country enters a recession. There might be widespread hiring freezes and job losses, lower wages, reduced business vibrancy, and a diminished appetite for investment activities. Investors will typically shun riskier assets in favour of more safe-haven assets like cash and high-quality, short-duration bonds.

Read Also: The Inverted Yield Curve: Does it Mean There’s A Recession Coming?

How Have Bonds Performed In A Recession?

Though bonds are considered safer than stocks, in a market recession, both asset classes may experience volatility and capital losses. Some investors may prefer to divest their holdings to stay in cash.

Looking at the performance of the different bond sectors over the last two recessions, in 2008 and 2020, bonds generally performed better than the S&P 500 Index. For example, during the 2008–09 recession, the US Aggregate Index and the US Treasury Index both had positive returns of roughly 9% and 11%, respectively, while the S&P 500 Index lost 36% around the same time.

Source: Darrow Wealth Management – 2008 Financial Crisis

Similarly, during the 2020 recession, both the S&P 500 Index and the ACWI Index fell by about 30% at their lowest points in March 2020. In the same timeframe, bond indices, consisting of US Treasury and US Corporate dropped less than 15%.

This shows the importance that bonds play in a portfolio as a source of diversification to reduce volatility and overall risk.

Source: Darrow Wealth Management – 2020 Financial Crisis

As with any investment, there are good and bad times to buy bonds, which are typically influenced by the interest rate. Given the inverse relationship between bond prices and interest rates, any increase in interest rates will cause bond prices to fall, while any decrease in interest rates will cause bond prices to rise. As a result, bonds with long-term maturities will be more affected by changing interest rates compared to short-term bonds.

In other words, in times of recession, where investors expect the Fed to lower interest rates to stimulate the economy, it may be good to stay invested in long-term bonds. In a rising interest rate environment, however, it may be better to stick to short-term bonds because bond prices are less sensitive to interest rate changes.

Why You Should Invest In Bonds During Recession

There are two main benefits of investing in bonds during a recession.

#1 Consistent Income Source

Bonds provide a consistent source of income because the issuing company is required to pay its debt in the form of coupon payments regardless of stock price volatility or economic conditions. Failure to make the coupon payment would amount to a default, and investors would be able to start an insolvency proceeding against it.

This is different from dividend-paying stocks, which can choose to stop paying dividends or cut the amount they pay out when the economy or company is doing poorly.

The income from the bonds can also be used to cushion the losses on the stock portfolio. At the same time, regular income from bonds also gives investors greater cash flow visibility. This can be especially crucial for investors who rely on the income from their portfolios to supplement their daily expenses.

#2 Potential Opportunities For Capital Appreciation

Bonds are usually seen as safer instruments compared to stocks. In times of recession or market uncertainty, investors will typically prefer holding on to safer, high-quality bonds compared to stocks. This creates higher demand for bonds, causing their prices to rise, which can be sold for a capital gain.

Similar to stocks, certain corporate bonds may also see a fall in bond prices due to market volatility. This gives investors a chance to buy these bonds below par value, which boosts their overall investment return upon maturity.

That’s where being able to search and filter for high-quality bonds is crucial.

How To Select Bonds That You Can Invest In?

There are many types of bonds that are available to investors, including corporate, high-yield, and government-issued bonds. These bonds also come with varying coupon rates and maturity periods.

Each investor may have a preference over the minimum yield they seek and the investment holding period that they are comfortable with. Naturally, the bigger the risk, the higher the potential reward.

Regardless, it’s important to choose a high-quality bond from a company with a good credit rating to lower the risk of a bond default.

Using Bondsupermart’s Bond Selector Tool, investors can easily sieve through a database of bonds for free based on their preferred criteria. As a wholly owned subsidiary of iFAST Corporation, Bondsupermart makes it simple for individual investors to find bond-related information, especially on Asian bond markets, and transact if need be.

For example, investors can narrow their search based on a few important filters like Issuer, Guarantor, Bond Type, Coupon Rate, Yield to Maturity and Years to Maturity.

The screen shot below shows 160 filtered results for a corporate bond with:
i) less than three years until maturity; and
ii) providing a yield of between 4% and 6%.

Source: Bondsupermart – Bond Selector (Screen shot taken as of 5 January 2023)

You can make the search results even more specific by using the advanced filter, which lets you choose, among other things, the bond currency, bond credit rating, bond sector, and coupon frequency.

Source: Bondsupermart – Advanced Filter

With the additional filters, the bond selection is now narrowed to a list of 10. You can also turn on the performance filter, which lets you view the returns generated over the life of the bond versus the current period.

Source: Bondsupermart – Bond Selector (Filtered Results)
(Screen shot taken as of 5 January 2023)

Another layer of study that can be done on Bondsupermart is to make comparisons between the different bond issues.

For instance, selecting the bank issuers from the filtered results and clicking on the Generate Comparison button will allow you to see up to 8 the different bond performance in relation to others. This feature allows you to quickly identify the bonds with the best and worst performance.

Source: Bondsupermart – Generate Comparison

The free and easy-to-use bond investment tools by Bondsupermart also consist of a Portfolio Builder function that lets you create your bond portfolio based on your desired yield and coupon frequency. With these tools, more investors would be able to put together a portfolio of bonds that meets their investment goals.

Even with bonds, it is important to remember that one should not overconcentrate in any one asset class. Instead, investors could even consider using bonds as a means of portfolio diversification, especially in a slowing economy that causes equities to slump or profit if interest rates fall.

Using the Bond Selector tool, investors can easily filter for only investment-grade bonds and be able to identify pockets of opportunity on these high-quality bonds by buying below par value or selling at a premium even during times of crisis.

Investors can also subscribe to the Bondsupermart’s Telegram channel to get information on the latest bond issues and research insights from regional analysts.

Read Also: How Is The Interest Rate Derived For The Singapore Savings Bonds (SSB) And Why It Is Increasing?

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