Income
is
back –
it’s
a
rule
of
thumb
in
financial
markets
after
rapid
interest
rate
hikes.
There
is
no
doubt
that
bonds
have
become
more
attractive
over
the
past
year,
but
will
they
take
the
place
of
dividends
in
investors’
portfolios?

“In
an
environment
of
high
volatility
due
to
increased
recession
risks,
investors
often
lean
toward
increasing
portfolio
allocation
to
bonds
at
the
expense
of
equities,”
says
Nicolò
Bragazza,
associate
portfolio
manager
for
Morningstar
Investment
Management
(MIM).

“High-quality
government
and
corporate
bonds
generally
offer
more
stable
returns,
and
they
are
the
most
conventional
source
of
diversification
in
this
context.”

However,
in
2022
we
learned
that
the
old
rule
of
thumb
(that
equities
and
government
bonds
are
always
negatively
correlated)
doesn’t

always

hold
true.

“Not
all
bonds
are
the
same,
so
it’s
important
to
understand
which
ones
are
best
suited
in
high
volatility
environment,”
Bragazza
says.

“On
one
hand,
high-yield
bonds
are
most
affected
by
volatility,
as
they
are
exposed
to
credit
risk.
On
the
other
side,
they
have
a
lower
sensitivity
to
interest
rate
risk,
as
their
duration
is
lower
than
those
of
a
typical
government
or
corporate
bond
index.”

Which
Bonds
Are
a
Good
Choice
for
Income
Investors? 

“If
the
investor’s
goal
is
income
generation,
high-yield
bonds
can
play
a
key
role
in
the
portfolio,
but
investors
should
be
aware
of
risks
in
high
volatility
markets,”
Bragazza
explains.

“Income
investors
should
also
look
at
emerging
market
debt,
both
in
local
and
hard
currency.”

High-yield
bonds
are
corporate
debt
securities
that
pay
higher
interest
rates
than
investment-grade
bonds
and
because
they
have
lower
credit
ratings.

Emerging
market
bonds
offer
exposure
to
government
issuers
with
different
risk
profiles
in
various
parts
of
the
world
and
can
therefore
offer
attractive
sources
of
income
and
diversification,
especially
when
compared
with
developed
markets.

Before
investing
in
emerging
market
bonds,
investors
should
evaluate
credit
and
currency
risks.

CoCo
Bonds
Are
Risky
Assets

Contingent
convertible,
or
“CoCo”,
bonds
have
attracted
a
lot
of
attention
recently.
They
were
introduced
to
many
portfolios
to
generate
income
during
the
past
decade’s
negative
rate
environment.
They
are
debt
instruments
primarily
issued
by
European
financial
institutions
and
have
a
strike
price that,
once
breached,
converts
the
bond
into
equity.

“We
learned
from
the
Credit
Suisse
crisis
that
CoCo
bonds
are
risky
assets,
and
investors
need
to
understand
their
risk
and
return
profiles,”
Bragazza
says.

“Here,
conventional
wisdom
may
help
us:
the
higher
is
the
yield
the
higher
is
the
risk,
and
this
should
be
carefully
weighed
when
constructing
the
portfolio.”

High-yield
bonds
may
be
appropriate
for
investors
whose
goal
is
to
generate
high
income,
but
these
bonds
are
poor
diversifiers.

“It
is
not
unusual,
especially
in
recessionary
phases,
to
observe
high-yield
bonds
losing
value
together
with
equities”,
says
Bragazza.

“However,
they
can
also
be
instrumental
in
maintaining
a
certain
degree
of
cyclical
exposure
with
a
lower
beta
than
that
of
the
largest
equity
markets.”

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