Global fixed income giant PIMCO has warned investors not to bail out of bonds despite rising interest rates in a study published last week.
The report – authored by PIMCO managing director, Robert Mead, and senior associate, Alex Smith – says investors considering selling bond holdings in anticipation of “meaningful” rate hikes “might not be [following] a prudent course of action”.
According to PIMCO, bond investors would likely only experience a brief period of negative returns if rates spiked up dramatically – say, from 50-100 basis points in one hit.
Under PIMCO’s expected scenario where US rates rise gradually to a lower neutral level than in previous hiking cycles, bond returns would be subdued in the short-term but actually benefit longer-term investors compared to the status quo.
The PIMCO study modelled outcomes for Australian bonds and global bonds (hedged to the A$) for four interest rate scenarios: no change, one-off 50 and 100 basis points rises, and four 25 basis points hikes over two years.
Australian bonds only fell in the first year following a 100 basis point hike scenario but were positive in all other scenarios over a five-year period, the study shows. Meanwhile, $A-hedged global bonds saw negative one-year returns in all three interest rate rise scenarios – significantly so following the 100 basis point hit – before turning positive during the next four years in all models.
From year three post the initial rise the PIMCO study shows all hiking scenarios would see bond investors achieving better returns than under a ‘no change’ world.
“This is because the yield being earned (primarily from coupons and reinvesting these at higher yields) is enough to offset the temporary mark-to-market losses that result from falling bond prices,” the report says.
PIMCO says historically bond market crashes have been shorter-lived and less extreme than equity bear markets.
“If markets are not timed perfectly, the investor typically pays a price since they may well miss out on the yield they would have earned by staying invested,” the study says.
Furthermore, PIMCO says the principal reasons for investing in bonds – capital preservation, steady income, diversification and protection from equity market falls – “remain as compelling as ever”.
“… investors who overreact to the prospect of rising interest rates may be doing themselves, and their investment portfolios, a disservice”, the report says.