In a shifting market, individual bonds, bond ETFs, and bond mutual funds remain a stabilizing force for endowments and foundations, with enduring significance in the investment portfolio of any nonprofit.
Nearly all of Mercer Advisors endowment and foundation clients maintain bonds (fixed income) as an integral part of their investment portfolios. Bonds are considered an important asset for achieving diversification. Recently, clients have wanted to understand why bond exchange-traded funds (ETFs) in their portfolio have fluctuated in share price. They’ve also asked whether bonds still make sense in a portfolio today, and whether they’re riskier than stocks. While the media certainly emphasizes the perceived risk, we believe fixed income remains an important component for most portfolios in the nonprofit sector. Here’s why:
Much of the share-price fluctuation of an individual bond, bond ETF, or bond mutual fund can be attributed to the inverse relationship between yield and price. As interest rates go up, prices go down (the opposite is also true: if interest rates go down, prices go up). If you’ve invested in an individual bond that yields 5%, for example, and new bonds are coming to market yielding 7%, the price of your bond must be lowered so that it’s attractive to buy. Imagine a seesaw on a playground, with interest rate on one side and price on the other.
If you have no plans to sell the bond, this becomes inconsequential—you simply hold on to the bond until maturity. Once the bond matures, you can reinvest for the yields current at that time, which is exactly what most bond funds do.
Vanguard Short-Term Bond ETF (BSV) is an investment vehicle that’s in some client portfolios. This fund has over 2,500 different bonds that mature on a regular basis. As they do, they’re replaced by new bonds available in the market. Essentially, the ETF functions like a perpetual diversified bond ladder, which is a portfolio of individual bonds that have staggered maturities. The ETF is professionally managed by Vanguard Fixed Income Group, with over $57 billion in assets in this one fund. Vanguard can purchase bonds in mass (much more than a nonprofit could on its own) and pass on the savings to shareholders of the fund.
Another important consideration is the concept of total return, which is yield plus or minus the bond or share price. With bonds, over 90% of the potential return comes from the dividend, and the dividend is always positive.
Here’s a snapshot of recent BSV performance to illustrate total return:
|Capital return by NAV
|Income return by NAV
|Total return by NAV
In 2022, the U.S. bond market had its largest and fastest increase in interest rates in the past 100 years. As a result, the capital return (price) of the bond ETF decreased by 6.9%. The income return (yield) remained positive, however: 1.35%. This was the worst year on record for BSV total return, down only 5.5%. By comparison, stocks can be down 5.5% in an instant and no one will blink.
While every foundation and endowment has its unique needs, goals, and risk tolerance, bonds should not be overlooked in a diversified investment strategy. In short:
Bonds (or bond ETFs and bond mutual funds) often make sense for a nonprofit organization because of their positive yield and the diversification they bring to a larger portfolio. Working closely with an investment advisor to determine the appropriate mix of stocks and bonds is key to ensuring that your portfolio is aligned with your investment goals, objectives, and risk tolerance.
Mercer Advisors Inc. is a parent company of Mercer Global Advisors Inc. and is not involved with investment services. Mercer Global Advisors Inc. (“Mercer Advisors”) is registered as an investment advisor with the SEC. The firm only transacts business in states where it is properly registered or is excluded or exempted from registration requirements.
All expressions of opinion reflect the judgment of the author as of the date of publication and are subject to change. Some of the research and ratings shown in this presentation come from third parties that are not affiliated with Mercer Advisors. The information is believed to be accurate but is not guaranteed or warranted by Mercer Advisors. Content, research, tools and stock or option symbols are for educational and illustrative purposes only and do not imply a recommendation or solicitation to buy or sell a particular security or to engage in any particular investment strategy. For financial planning advice specific to your circumstances, talk to a qualified professional at Mercer Advisors.
Past performance may not be indicative of future results. Therefore, no current or prospective client should assume that the future performance of any specific investment, investment strategy or product made reference to directly or indirectly, will be profitable or equal to past performance levels. All investment strategies have the potential for profit or loss. Diversification does not ensure a profit or protect against a loss. Different types of investments involve varying degrees of risk, and there can be no assurance that any specific investment will either be suitable or profitable for a client’s investment portfolio. Economic factors, market conditions, and investment strategies will affect the performance of any portfolio and there are no assurances that it will match or outperform any particular benchmark.
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