There is a growing appreciation as we enter 2023 that after many years in the wilderness due to rock-bottom interest rates, bonds once again deserve a place in a balanced portfolio.

Howard Marks of Oaktree Capital Management argues that base interest rates are not going to return to between 0% and 2% in the future but are likely to remain between 2% and 4% for a considerable time.

In that scenario, Marks says investors can now potentially get solid returns from credit instruments, ‘meaning they no longer have to rely on riskier instruments to achieve their overall return targets.’

Bonds are a form of credit instrument. Investors buy bonds from governments or companies in exchange for regular interest payments and the original issue price of the bond is returned to them
after a specific period.

BlackRock – the world’s biggest money manager – believes after four decades of relatively stable economic activity and inflation known as The Great Moderation we have entered a new regime of greater macro and market volatility, requiring us to rethink the appeal of bonds.

‘Higher yields are a gift to investors who have long been starved for income, and investors don’t have to go far up the risk spectrum to receive it,’ says the firm.

It favours short-term government bonds and mortgage securities as well as high-grade corporate credit, ‘as we see it compensating for recession risks.’

On the other hand, long-term government bonds won’t play their traditional role as portfolio diversifiers due to persistent inflation, says the firm, as investors are likely to demand higher compensation for holding them as central banks tighten monetary policy at a time of record debt levels.

Therefore, investors might want to prioritise high-grade corporate credit for their portfolio as it brings an attractive and stable income stream. Rather than try to cherry-pick individual bonds or fund managers we would opt for a low-cost corporate bond ETF (exchange-traded fund).

The iShares $ Corporate Bond ETF (LQDS) is quoted in pounds, has a dividend yield of 3.75% and an ongoing charge of just 0.2%. Its objective is to provide investors with a total return reflecting that of the Market iBoxx Liquid Investment Grade index of US corporate bonds.

Befitting the focus on liquid, high-grade credit, the top holdings include bonds of well-known US companies such as Annheuser-Busch (BUD:NYSE), AT&T (T:NYSE), Boeing (BA:NYSE), Goldman Sachs (GS:NYSE) and Wells Fargo (WFC:NYSE).

Over the past one month, three months and 12 months the ETF has generated total returns of 0.7%, 3.8% and 8% respectively.

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