Portfolio Update: Going Long on Bonds
A couple years ago, we decided to take a more conservative approach in our fixed income portfolio and replace DFA’s Five Year Global Bond fund with its One Year Fixed Income fund, which carries an average maturity of less than one year. We made this decision in response to what we were observing in the economy at the time: the Federal Reserve had committed to gradually increasing rates and inflation had crossed the 2% threshold for the first time since 2014.
Given those factors, the best approach to take in relation to the fixed income portion of our portfolio was to shorten the average maturity.
Since then, the Fed has made good on its promise and raised the Federal Funds rate from 1% to 2.5% over the past two years, and inflation has settled at the Fed’s target of 2%. Current expectations are that there will be no more rate hikes this year, and there are rumblings of the potential for a rate cut in the future as the US/Chinese trade war and uncertainty in the European Union drag on. In response to these factors, we’re adjusting our bond portfolio and lengthening the average maturity by switching back to the afore mentioned DFA Five Year Global Bond Portfolio. Notwithstanding the new fund’s name, its current average maturity is closer to three years than five. Also, consistent with its name, this is a global portfolio, with only about 15% allocated to U.S. bonds. The fund also hedges against exchange rate fluctuations in order to minimize volatility from that source.
To reduce the overall risk of our fixed income portfolio, we’re also introducing a money-market fund to the mix. Our goal is to employ a combination of this fund and the five-year bond fund that will maximize returns while mitigating the risk of a longer average maturity with the guaranteed returns provided by the money market fund. In general, the five-year bond fund will make up 2/3 of our Clients’ fixed income portfolio while the money market fund will account for the rest.
As always, we’ll continue to be vigilant with respect to global monetary conditions and the inflation outlook with the objective of maximizing the yield we’re capturing in the world’s bond markets.