Morningstar - Q2 2023 - 5

Letter From the Editor
Bonds and Risk
Jerry Kerns
One lesson the market regularly teaches us is that
risk is a fundamental element of investing and
the fuel that powers returns. In the equity markets,
we (re)learn this every 10 years or so. Stocks
go up for a time, become overpriced, and then fall
in a correction. As valuations become more
enticing, the market regroups and goes on to
new highs, and the cycle repeats.
Because stocks are volatile, investors have
counted on bonds to balance out the risk. They're
told that as they get closer to their investing
goals, they should pare back on equities
and increase their allocation to fixed income.
Target-date funds are built on this notion.
Well, as we've learned lately, the markets don't
always act like we think they should. " During a
bear market for stocks like last year's, bonds
should have helped a portfolio, not inflicted more
damage, as was the case in 2022, " writes
data journalist Lauren Solberg in this issue's lead
Spotlight article, " Don't Lose Faith in Fixed
Income, " Page 27. It turns out that bonds aren't
always the diversifiers they're purported to be.
Some investors learned a different lesson,
though-that diversification no longer makes
sense or that the 60/40 portfolio is dead.
Morningstar has a different view. As Solberg
points out, the relationship between stocks and
bonds was never set in stone, especially
during high inflation, but that doesn't mean
diversification doesn't work.
In fact, bonds' historically bad performance sets
the stage for their return-both in terms of
performance and diversification. In " Is It Time
to Pick Up the Pieces? " Page 32, manager research
director Eric Jacobson says that although a
lot has gone wrong, eventually things will go right.
Problem is, as he shows, many investors have
bailed on bonds, or at least cut their holdings. As
we always preach, picking the right time to get
back into the market is tricky. The key is to stay the
course on your overall investment strategy. Writes
Jacobson, " If one regularly rebalances their
portfolio and already holds enough bonds to match
their goals and risk tolerance, simply waiting
for the market to normalize before buying more
might be the best option. "
With risk top of mind after this past year, Leslie
Norton, Morningstar's editorial director for
sustainability, writes that one approach is to use
the tools provided by environmental, social,
and governance investing ( " Sustainable Bonds
Present New Opportunities, " Page 36). As
ESG data becomes more widely available, investors
can better identify issuers' material risks and
how they're managing them. " Strong ESG
practices such as diverse boards and workplace
safety can help identify the best-managed
issuers, " Norton says.
Finally, Don Phillips takes the bond-fund industry
to task in " Return-Free Risk, " Page 8. In 2022,
the message from bond index shops was to stay
the course, he says, even though going into the
year most signs pointed to there being little
value left in bonds. Phillips recalls that " an earlier
generation of fund leaders opted for a higher
road, " namely Vanguard's Jack Bogle, who
told investors to avoid foreign stocks. " Where was
that kind of leadership in the industry in 2022? "
Phillips asks.
Risks abound in investing, even among staid
investments like bonds. Whether investors
maintained their allocations last year or were
astute enough to make moves to minimize
the carnage, bonds won't be outcasts forever.
They should remain an important part of
most portfolios.
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Morningstar - Q2 2023

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