![]() But following the Federal Reserve’s (Fed) aggressive rate hikes in 2022, coupled with inflation starting to cool more recently, 5-year U.S Treasury bonds are now offering substantially positive real yields. Consequently, bonds have had a hard time beating inflation over that period. The second metric we need to consider is real yield, or nominal yield less expected inflation.Īs shown in Figure 3, since 2008, real yields on 5-year U.S Treasuries have been negative for the majority of the time. While nominal yield is a helpful starting point, it does not tell us anything about fixed income’s ability to outpace inflation. Past performance is no guarantee of future results. Agg 5-year annualized forward returns period from Januto January 31, 2018. Agg yield to worst period from Januto January 31, 2023. Source: Bloomberg, as of January 31, 2023. Agg YTW and 5-year annualized forward returns (1976-2023) Therefore, we believe investors would do well to pay attention to their starting yield.įigure 2: U.S. As shown in Figure 1, current YTW and 5-year annualized forward returns have been highly correlated for the U.S. ![]() The first valuation tool bond investors may use is to simply consider the current yield to worst (YTW) on the Bloomberg U.S. To provide a framework for this assessment, we highlight five key bond valuation metrics below. In our view, bringing valuation to the table may lead to better risk-adjusted returns in fixed income. We believe bond investors would do well to consider valuation metrics as they determine how much to allocate to fixed income, and which sectors to allocate to. Likewise, whereas most investors might have an opinion on whether equity securities are cheap or expensive, they do not tend to think about bonds the same way. While investors typically track equity valuations on an asset class, style, sector, and security basis, this same approach does not often carry over to fixed income. ![]() Instead, everyone will likely pause for some inner pondering before responding with a bevy of different answers. ![]() Now, ask for the group’s preferred bond valuation measure and you’ll probably get anything but a consensus. Poll a group of investors on their preferred equity valuation metric and you’ll likely be met with a consensus response: the price-to-earnings (PE) ratio.
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