Over the past few years, yield levels have sparked questions around the role of bonds in asset allocation. Pre-pandemic bond yields were very low, and by the end of 2019, the average developed market yield was just 94 basis points. Investors worried that bonds faced asymmetric risks: yields had limited room for further declines and were bound by a floor, which limited any potential upside. However, prices could drop should yields rise.
When bond yields dropped even more during the pandemic, eventually reaching an average of 37 basis points by the end of 2020, investors became further concerned.
So far, in 2021, bond yields have been trending higher but remain near pre-pandemic lows, with a current average yield of 96 basis points. While the yield increases provide a little bit of breathing room, investors still question whether bonds will be able to generate an attractive return and provide diversification. At what point is the role of bonds in an asset allocation impaired?
The role of bonds in equity drawdowns and “stress scenarios" (0:28):
We believe that the existence of a floor doesn’t doom bonds – only very restrictive yield floor assumptions matter. Our research has shown that if yields were to drop 100 basis points or more over the next year, a bond portfolio would not be impaired and traditional and risk balanced asset allocations would behave as if no yield floor existed.
The return-generating properties of bonds in risk-balanced portfolios (0:20):
Given the yield increases in early 2021, we think a 100 basis point drop in yields is possible. Our goal is to help investors identify the point where their yield floor view materially impacts asset allocation in practice, or the point where bonds' return generation and diversification properties are impaired.
Evaluating your yield floor view and its impact on asset allocation (1:03):
Source: AQR, Bloomberg. Yields above are the 10-year government bond yields for Australia, Germany, Canada, Japan, the United Kingdom, and the United States. The “floors” are purely for illustrative purposes and are meant to represent hypothetical “lower bounds” for yields. Hypothetical data has inherent limitations of which some are disclosed in the appendix. No representation is being made that any investment will achieve performance similar to those shown.
AQR Capital Management, LLC, (“AQR”) provide links to third-party websites only as a convenience, and the inclusion of such links does not imply any endorsement, approval, investigation, verification or monitoring by us of any content or information contained within or accessible from the linked sites. If you choose to visit the linked sites, you do so at your own risk, and you will be subject to such sites' terms of use and privacy policies, over which AQR.com has no control. In no event will AQR be responsible for any information or content within the linked sites or your use of the linked sites.
The information contained herein is only as current as of the date indicated, and may be superseded by subsequent market events or for other reasons. The views and opinions expressed herein are those of the author and do not necessarily reflect the views of AQR Capital Management, LLC, its affiliates or its employees. This information is not intended to, and does not relate specifically to any investment strategy or product that AQR offers. It is being provided merely to provide a framework to assist in the implementation of an investor’s own analysis and an investor’s own view on the topic discussed herein. Past performance is not a guarantee of future results.
Hypothetical performance results have many inherent limitations, some of which, but not all, are described herein. The hypothetical performance shown was derived from the retroactive application of a model developed with the benefit of hindsight. Hypothetical performance results are presented for illustrative purposes only.
Diversification does not eliminate the risk of experiencing investment loss.
Certain publications may have been written prior to the author being an employee of AQR.
This material is intended for informational purposes only and should not be construed as legal or tax advice, nor is it intended to replace the advice of a qualified attorney or tax advisor.
AQR Capital Management is a global investment management firm, which may or may not apply similar investment techniques or methods of analysis as described herein. The views expressed here are those of the authors and not necessarily those of AQR.