Morningstar - Fall 2019 - 37

2.5
2.4
2.0

EXHIBIT 4

-5

Historical U.1970
S. Treasury Yield
1960
1980 Curve Earlier
1990 this year,
2000the yield curve
2010 inverted,
2019
meaning the yield on the 3-month T-bill moved above that on the 10-year note.
June 2016

December 2018

June 2018

May 2019

June 2019

Yield
3.0%
2.5
2.0
1.5
1.0
0.5
0

1-Mo
3-Mo
Maturity
Source: Morningstar.

6-Mo

1-Yr

2-Yr

the years after the rate shock, the investor
who bought and held the portfolio would have
recouped losses and moved back into the
black on the investment within three years of
the rate shock.

3-Yr

5-Yr

7-Yr

10-Yr

buy back stock, and pay dividends. Meanwhile,
Federal Reserve officials have begun
issuing warnings about the overall rise in
corporate debt.

In general, investors worried about central bank
interest-rate increases should tilt their
bond portfolios toward shorter-term bond funds.
But even these carry risks. Many investors
piled into bank-loan funds during the 2018 series
of Fed rate increases only to see losses
at the end of the year thanks to a sell-off in the
low-quality loans those funds tend to own.

For investors worried about this trend, that means
applying prudence when buying corporatebond funds and tilting portfolios toward funds that
have higher-quality debt and fewer high-yield
bond holdings. For example, that could include
swapping out a fund that lands in the intermediate
core-plus bond Morningstar Category for one in
the intermediate core bond category, which tends
to have higher-quality portfolios.

Scenario 3: Widening Credit Spreads
Morningstar Investment Management argues
that the importance of focusing on bond quality
should not be underestimated in current
markets. It notes that BBB rated issuers-those
just one notch above so-called junk status-
now account for around half of the whole
investment-grade market in the U.S. and Europe.
There are several reasons for this. To name
a few: Firms are using debt to fund acquisitions,

Scenario 4: Yield-Curve Inverting
Headlines have been dominated by the concepts
of yield-curve inversion and recession risk.
Normally, long-term interest rates are higher than
short-term rates. An inverted yield curve is
when the picture goes in the opposite direction-
that is, long-term interest rates are lower
than short-term ones. In early 2019, the yield on
the U.S. Treasury 3-month bill moved above
the yield on a U.S. Treasury 10-year note, the first

time this alignment took place since before
the financial crisis ( EXHIB IT 4 ).
Even if this bond market signal has a pretty
compelling track record of predicting recession,
for Morningstar Investment Management,
the focus is on the opportunity set in the market.
In the case of the inverted yield curve, that
means investors can earn just as much in yield on
low-volatility short-term debt as they could on
longer-term debt.
The real question here is whether bond investors
have predictive abilities over the economy
or markets. When it comes to managing a portfolio,
investors should only really care about the
markets. It is useful to understand risk, but it is not
something that should directly affect investment
decision-making. The better approach is to
think about duration, where an investor is typically
not rewarded for holding longer-term bonds.
Think Long Term
Bonds have their own sets of risks that are
important to understand, but they can
provide both an anchor in times of market and
economic uncertainty and an opportunity
for additional returns.

As with any investment, choices around bond
investments should be made in the context of a
broad financial plan and meeting financial
goals. Investors can consider other factors across
their investment portfolio that can help meet those
goals, such as keeping investment costs low,
not chasing after hot corners of the market, and
not bailing on a long-term plan in the face of
short-term losses. K
Tom Lauricella is an editorial director with Morningstar.
Christine Benz is director of personal finance
with Morningstar.

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Morningstar - Fall 2019

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