How to manage bonds at record low rates

Mar 9, 2021
  • Karen Schenone, CFA
  • Shayan Hussain, CFA

Market challenge: adapting to near-zero interest rates

The #1 challenge investors face in 2021 is how to manage pressure on bond portfolios given record low yields. When interest rates fall, expenses matter more than ever as high fees can eat up a big chunk of your income. With the Fed signaling low interest rates are here to stay for the foreseeable future, now is the time to consider redesigning your portfolio.

Prepare portfolios for 2021 and beyond

Step 1: start with the BlackRock Bond Pyramid

 Bonds can be used for three primary purposes - income, capital preservation or equity diversification, but no bond fund can provide all three. One common mistake many aggressive equity investors make is buying speculative bonds, which can offer the potential for generous income, but also add more risk to an already stock-heavy portfolio. As your overall portfolio allocation gets more aggressive, the bonds within it may actually need to be more conservative to provide a hedge against risk. We call this “The Bond Paradox.” When building your bond portfolio, it’s important to consider what role each of your bond funds play, and then optimize your bond mix based on your larger asset allocation. That’s where the BlackRock Bond Pyramid comes in. An aggressive equity investor needs their limited bond allocation to diversify stocks. That means they should consider owning conservative bonds with high credit quality ratings and longer duration. On the other hand, a conservative investor who has less stock risk may want to dip more into credit and higher income bond funds for potentially higher yield.

Bond Pyramid

Step 2: barbell each rung of your pyramid

Once you understand the role each of your bond funds play in your overall portfolio, you can then customize the rungs of your pyramid. We advocate for using a barbell approach. The left side of the barbell is about keeping fees low and transparency high with bond ETFs. This allows you to allocate the remainder of your fee budget to your right set of weights, where you’ll seek excess returns with flexible and alternative active strategies. Beware of the traditional bond mutual funds in the middle that demand a high fee for benchmark-hugging active exposures.

Barbell Pyramid

For illustrative purposes only.

See it in action

Let’s say your primary goal for your bond portfolio is to offer a hedge against risk when stocks inevitably sell off. You’d want to build an equity diversification barbell. Begin with a broad-market ETF, like iShares Core U.S. Aggregate Bond ETF (AGG), as your core bond allocation, and then look to your active manager to offer compelling return. An unconstrained fund, like BlackRock Strategic Income Opportunities Fund (BSIIX), can complement your core bond fund by providing the potential for income and total return.

What’s the bottom line?

Bond ETFs can be used as a core component to any portfolio. They seek to provide competitive performance and are an efficient way for investors to lower costs and add liquidity. At the same time, actively managed unconstrained funds can introduce new potential sources of return by providing exposures you can’t get from an index fund. When redesigning portfolios, investors can optimize their fixed income allocation for fees and yield by pairing flexible funds alongside bond ETFs.

Explore ideas to get started

When redesigning fixed income portfolios, investors can optimize their allocation for fees and yield by pairing flexible, active strategies alongside bond ETFs.
 Low cost fixed income
Find low cost fixed income exposures
Don’t let high fees eat up yields. Bond ETFs are a low fee, high transparency option for fixed income allocations.
Unconstrained Active Sources
Find unconstrained active sources of income
Explore a flexible strategy like the BlackRock Strategic Income Opportunities Fund (BSIIX) which seeks consistent returns by managing interest rate volatility.