Many people equate bonds with safety. Investing in country or corporate debt should deliver a reliable yield with small fluctuations in principal.
Over the last few years, however, investors have had to take on longer term bonds (i.e., 10-year plus) to come close to 5%. And they’ve had to hold firm to the notion that the Fed wouldn’t raise interest rates in the foreseeable future; yet, if the marketplace were offering U.S. Treasuries for 5.75% or 6.25%, bonds at 5% or less would fall in price/value.
The Fed hasn’t raised interest rates… but the fear is palpable. It follows that the Lehman Aggregate Bond Index Fund (AGG) struggled in the first half of 07. Through June 26, AGG is barely in the plus column, yielding something less than 1/3 of one percent.
Will it get better before it gets worse? It depends on whom you ask. The consensus seems to be that the Fed may be on hold for the remainder of 2007. If that’s the case… the Lehman Aggregate Bond Index Fund (AGG) may be lucky to squeeze out a 1% or 2% gain on the year.
If, on the other hand, the Fed began to indicate a need to cut rates to help out an ailing housing segment before year’s end, falling bond yields could boost bond prices. And that might make the Lehman Aggregate Bond Index Fund (AGG) attractive. (I’d wait until September to see how this plays out.)
In the meantime, it’s hard to feel sorry for those who over-allocated to bond assets. Longer-term interest rates have been creeping up. What’s more, if that trend continues, the new bond buyers would benefit whereas the old bond holders would only experience "portfolio drag."
In other words, if you’ve been stuck in the Lehman Aggregate Bond Index Fund (AGG), there’s not much you can say. It’s been a drag so far. (You get close to 2.4% in yield, but your investment has depreciated nearly 2.1%).