Can bonds compete with equities when it comes to yield?

According to recent prints from a wide range of economies, global inflation has yet to be tamed. 

The impact of rampant inflation has been felt across asset classes, presenting a material challenge for investors. But its legacy is a compelling opportunity.

Ready to compete

While government bond yields have proved to be rather volatile as policy rate expectations change dramatically , they are at levels significantly above those seen in most of the last 10 years. As a result, bonds can finally compete with equities as a yield- generating asset class.

Investment grade credit in the UK and US offer well over 5% yields. High-yield markets are giving us more than 7%. Clearly, traditional income-generating assets are back in play.

Lower risk?

While other assets offer both income and the scope for capital gains, bonds can now take their rightful places in diversified portfolios. We believe they currently offer a lower-risk source of income.

That’s not to say that bonds are risk-free. But the yields available provide a decent amount of comfort, as well as the potential for inflation-beating returns. In an uncertain world, we think the case for holding bonds in your portfolio is stronger than it has been for some time.

Something for everyone

The enormous bond universe offers something for everyone. Each type of bond merits consideration for a place in a diversified portfolio.

As we've mentioned, high-yield corporate bonds can offer yields approaching 8%. While that market comes with risks if the global economy slows, it also offers scope for capital appreciation if the macro situation continues to improve.

Building stability

At the other end of the spectrum, government bonds can, once again, offer potential stability in a diversified portfolio of risky assets. The risk to this asset class primarily comes from the best possible economic outcome, where growth picks up and inflation comes back. But this situation is likely to help those riskier asset classes.  

Investment grade credit should offer a little bit of both. Investment grade yield is made up of a combination of underlying government bond yields and credit premiums, also known as spreads. A negative economic outcome may cause those spreads to rise but would force yields lower. While a positive economic outcome may push up yields, but keep a lid on those spreads.

Back in the game

Bonds of all shapes and sizes are returning to popularity. Yields are competitive and relatively attractive; markets are liquid and accessible, and bond volatility is likely to be materially lower than equity volatility.  

Roger Webb is deputy head of sterling investment grade at abrdn.

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