One of the most dangerous things you can do as an investor is to chase performance. But for those who've bought bonds despite low interest rates, performance-chasing has paid off extremely well, and at least one well-known money management company thinks that certain pockets of the bond market have even further to rise.
Around the world with bonds
Yesterday, Fidelity Investments came out with its outlook for the global bond market in 2013. As familiar as U.S. investors may be with the current status of bond rates and their impact on interest on bank accounts, what may be surprising to some is that globally, bond market performance in 2012 largely outpaced the U.S. bond market. In Europe, for instance, the Barclays European Aggregate Bond Index rose more than 10%, far outpacing the roughly 4% return that the equivalent iShares Core Total U.S. Bond Market (NYSEMKT: AGG ) returned in the past year. Even bonds from economies in danger of major disruptions, including Greece and Italy, saw major rebounds in their bond prices during 2012, sending yields lower and making it easier for their respective governments to finance their debt.
What's behind the steady movement of higher bond prices and corresponding lower yields? Fidelity identifies demographics as a significant factor. As populations both in the U.S. and around the world skew older, the number of older people trying to save for their future grows compared to the number of younger people borrowing to invest in their future. That in turn increases demand for investments, increasing their price and forcing savers to accept lower yields as a consequence.
Moreover, other factors have combined to increase demand. Regulators want financial institutions to have safer balance sheets, and the sign of safety they prefer to see is more bond investments in their portfolios. Meanwhile, as growth slows down around the world, the potential returns on equities and other alternatives to bonds start to fall, making bonds look more attractive on a relative basis even with low rates.
Where to look for deals
In order to find the best niches of the bond market, following those factors is crucial. Corporate bonds are more attractive than government bonds, according to the report, because borrowing demand has been relatively low among businesses. With the ravenous demand for corporate bonds in the U.S., issuers across the credit-quality spectrum have largely been able to find financing and extend debt maturities to the point where relatively few companies face major refinancing needs in 2013. Even with Costco (NASDAQ: COST ) and Murphy Oil (NYSE: MUR ) among the many companies that went to the credit markets expressly to increase their leverage by turning around and paying out bond proceeds to shareholders in the form of special dividends, tight supplies of corporate bonds have led to ever-shrinking spreads between Treasuries and corporate bonds.
The other place Fidelity identifies as being particularly promising is in those areas of the world seeing structural improvements in their economies. The report specifically mentions Mexico, Malaysia, and South Korea among emerging markets with promising potential, but a combination of country-specific and broader international bond exposure may be more prudent for most investors. For instance, Aberdeen Asia-Pacific Income (NYSEMKT: FAX ) is a closed-end fund that specializes in bonds from Australia and the Pacific Rim, while the iShares JPMorgan Emerging Bond ETF (NYSEMKT: EMB ) gives investors a convenient way to buy dollar-denominated emerging-market bonds without currency risk.
One of the odd things about assessing the bond market is that its future success depends in part on economic growth maintaining a Goldilocks-like scenario of slow but not too slow growth. If growth accelerates, stock markets will soar and take capital out of the bond market. If growth falters entirely, then concerns about default start to rise. But the environment of the past four years since the 2008 financial crisis has been just about perfect for bonds, and as long as it continues, then bonds have a chance of providing decent returns even in the face of extremely low rates.
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