US Bonds: Good News for Income Investors

Morningstar Investment Management's Dan Kemp speaks to Emma Wall about rising US bond yields and where he sees value for investors

Emma Wall 12 March, 2018 | 3:59PM
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Emma Wall: Hello, and welcome to the Morningstar series, "Ask the Expert." I'm Emma Wall and I'm joined today by Morningstar Investment Management's Dan Kemp.

Hi, Dan.

Dan Kemp: Hello, Emma.

Wall: So, good news for income investors. U.S. bond yields have risen, haven't they?

Kemp: They have. And I think that's exactly the way to think about it. So, often when we see bond yields rising, it's because prices are falling, and people worry about the overall value of their capital. But that's very much a backward-looking view.

From a forward-looking perspective, then yes, rising bond yields means more income for people and also a better overall total return. So, we've been quite negative about bonds, as you know, for the last couple of years. And we've really stayed away from bonds as far as we can. But now, just for the first time in a little while bonds are starting to look more attractive, but not all bonds, specifically U.S. treasuries.

Wall: And this is good news not only because there's another place to look for income, and that means diversification. What about at what price? Because I know that you guys are all about valuation and diversification. So, the valuation element, what does that look like?

Kemp: Well, that's right. And it's really the valuation is driving us to look a little bit more at U.S. treasuries. As you know, the newspapers and websites about full of concerns about U.S. inflation and that maybe why prices have been moving. It's certainly why the commentators think prices are moving. But really when we see prices like that, when we see band news, when we see concerns about inflation, that's normally the time to take a sober look at valuations and from a valuation perspective, U.S. treasury bonds are now looking attractive.

The challenge for U.K.-based investors is that if you are buying U.S. treasuries, typically you are buying the U.S. dollar and that's not so attractive. And so, in our portfolios, we are looking for hedged share classes to avoid having to have the dollar exposure alongside the bonds.

Wall: And this is very much a specific story to U.S. bonds and to U.S. treasuries? Or are there other pockets of value globally when looking to allocate bond within your portfolio?

Kemp: Well, there's not very much, which is why we are getting interested in U.S. bonds because that's really where we have seen the pain over the last couple of months in terms rising yields and falling prices. European bonds, U.K. bonds and corporate bonds still all look pretty expensive to us. So, they might have a role in diversification, as you say. But in terms of a source of return, they really don't look attractive. So, whenever building a portfolio, it's really important to not just think about the diversification but having different sources of returns.

Wall: Dan, thank you very much.

Kemp: Thank you.

Wall: This is Emma Wall for Morningstar. Thank you for watching.

The information contained within is for educational and informational purposes ONLY. It is not intended nor should it be considered an invitation or inducement to buy or sell a security or securities noted within nor should it be viewed as a communication intended to persuade or incite you to buy or sell security or securities noted within. Any commentary provided is the opinion of the author and should not be considered a personalised recommendation. The information contained within should not be a person's sole basis for making an investment decision. Please contact your financial professional before making an investment decision.

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Emma Wall  is former Senior International Editor for Morningstar