11/16/13 Bond strategies for today's markets

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Bond strategies for today's marketsTherightreactiontoratesdependsonyourgoals.Herearefivestrategiestoconsider.

FIDELITY VIEWPOINTS 11/13/2013

Investing in Bonds Bond Funds Bonds

Conditionsinthebondmarkethavebeenunprecedentedinmanywaysduringrecentyears

above-averageperformance,ratesnearall-timelows,and,morerecently,oneofthefastestrate

jumpsinmanyyears.Withsomuchofthebondmarketbeingoutsidethelimitsofaninvestors

experience,bigquestionshavecomeup:Canbondsprovidevaluetoinvestorsgiventhelimited

upsideforpriceincreasesandthelikelihoodofrisingratesinthefuture,andwhatrolecanthey

playinyourportfolionow?

Todaysratesareunusuallylow,anditdoesseemlikelythat,overtime,rateswillmovehigher,

saysJulianPotenza,amacroandassetallocationanalystonFidelitysfixedincometeam.Many

investorsthinkwewillreturntonormalratessoon,buttherearesomegoodfundamental

reasonsfortodayslowrates,includingsloweconomicgrowth,lowinflation,andanaging

population.Thereisnoreasonratescantstayrelativelylow,andintheeventofarecessionor

globalcrisis,itispossiblethatmarketrateswillactuallyfallanoutcomethemarketmaybeunderappreciatingcurrently.

Regardlessofwhathappenstorates,Fidelitysbondteamstillbelievesthatbondscanprovidemeaningfuldiversification,deliverincomewithlowerlong-

termvolatilitythansomeotheroptions,andhelpinvestorspreparefortheirgoals.Thekeyformostinvestorsistorememberwhytheyownbondsatall.

Manyinvestorshaveastrategicplanthatincludesanallocationtobonds.Itmaybeworthrememberingthatifyouownbondsforstrategicreasons,itmay

notmakesensetomakeatacticalmoveoutofbondsbecauseyouareworriedaboutthecurrentmarketdynamicevenifitistemptingtodoso.Predicting

futureinterestrateshasprovedchallenging.Wethinkabetterstrategyistoadoptabalancedinvestmentallocationyoucanlivewiththroughmanydifferent

marketconditions.

Thinking about your investment timeline

Noonelikestoseethevalueofafundorthepriceofhisorherbondfall,saysGeorgeFischer,managingdirectorofresearch,macroeconomicand

structured.Butbondinvestorsneedtorememberthatpriceisjustonepartoftotalreturn.Makingtacticalmovestoreducebondmarketexposureorlessen

theimpactofratechangesonyourinvestmentmaymakesenseifyoucantaffordshort-termlosses,butifyouareinvestingstrategicallyandhavealonger

timehorizon,itprobablydoesntmakesense.

Thatsbecauserisinginterestrateshurtbondpricesintheshorttermbondfundsseetheirnetassetvaluefallandindividualbondstendtosufferprice

declinesinthesecondarymarket.However,overalongerperiod,risingratesmayactuallybenefitbondinvestors.Fundsmaybeabletoproducemore

incomeovertime,andindividualbondinvestorsmaybeabletobuysecuritiesthatofferhigheryieldsdowntheroad.

Sohowcanyoutellifthebenefitsofrisingincomewilloutweightheshort-termpricelosses?Astrategycalledimmunizationmaybeabletohelpyou

ensurethatthebenefitsofpotentialrateincreasesoutweighthedownside.Immunizationalignsyourinvestmentswithyourtimelineusingameasurecalled

duration.Durationestimatestheimpactinterest-ratechangesmayhaveonbondprices,andbychoosingabondportfoliowithadurationlessthanthe

amountoftimeyouplantobeinvested,yourincreasedincomefromaratechangeshouldoutweighthepricelossesduetorateincreases.

Lookatasimplifiedexamplebelow.Letssayyouexpecttoinvestforsevenyears,butchooseabondfundwithadurationoffiveyearsthoughthesame

principlewouldapplyifyouboughtabondeachyearwiththesameduration,andsolditattheendoftheyear.Ifratesdorise,theincomebenefitsshould

morethanoffsetthepriceafterfiveyears.Andinthisexample,theportfolioperformsbetterinarisingrateenvironmentthanafallingrateenvironmentafter

sevenyears.Thisexampleissimplifiedtoillustratetherelationshipbetweenpriceandincomewhenratesgoup,anditisimportanttonotethatitdoesnt

takeintoaccountissuesliketransactions,liquidity,changesinbondpricesduetohowthemarketperceivestheriskoftheissuer,ormarketevents.Allthese

thingscouldaffectthetotalreturnofabondinvestment.

How rising rates can benefit bond investors

11/16/13 Bond strategies for today's markets

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How much of a loss can you stomach?

Source:Long-termTreasuriesrepresentedbyIbbotsonAssociatesLong-TermGovernmentBondIndex;high-yieldbondsbyBankofAmericaMerrillLynchHighYieldMasterIndex.Sources:HaverAnalytics,preparedbyFMRCo(AART);IbbotsonSBBI2012ClassicYearbook.

View Larger Image

Shorter durations generally mean smaller

price changes when rates change

Source:FMR.AssumesstartingyieldcurveasofOct.8,2013(10-yearratesapproximately2.7%).Interestratesatallpointsalongthecurveconvergetoroughly6.1%(risingratepath)or1.7%(fallingratepath).Thisconvergencehappensatalinearrateoverthecourseoffiveyears.Theillustrativeinvestmentismadeinfive-yearzero-couponbondswithyieldlevelsinitiallysetbytheTreasurycurve.Inaddition,theinvestmentisrolledoverannually(afour-yearbondissoldandafive-yearbondispurchased).Thisisanillustrationanddoesnotrepresentactualperformanceforanyspecificfund.Actualperformancewillvary.

1. Goal: Generate income now

Investorslookingforincomehavefacedseriouschallenges:AsofSeptember30,2013,mosttypes

ofbondsstillpaidyieldsinthebottom20%ofhistoriclevelsdespitetherecentincreases.To

beatinflationorachieveincomegoalsmanyinvestorshaveturnedtohigher-yieldingoptions,

namelylonger-maturitybondsorlower-qualitybonds.Theseinvestmentscanofferanincreased

incomestream.Ofcourse,theaddedincomecomeswithadditionalrisk.

Therecentrateincreaseshighlightedtheriskthatpriceswillfallasratesgoup,andlonger-

maturitybondsaremoresensitivetoratechanges.Involatilemarkets,liquidityriskandcreditrisk

canbeimportantfactorsaswell.Soifyouareinvestingforcurrentincome,youneedtobalance

thelevelofincomeyoucanachievewiththeamountofriskyoucantoleratebasedonhowlong

youcaninvest,thelikelihoodyouwillneedtoaccessthemoney,youremotionalrisktolerance,

andotherfactors.

Findinvestment-gradebondfundsandhigh-yieldbondsfunds.

Orlookforindividualinvestment-gradebondsorhighyieldcorporatebonds.

2. Goal: Investing for the short-term

Forinvestorswhoneedtheirmoneyinthenearfuturesayretireescountingontheirprincipal

forlivingexpensesorparentssavingforcollegeexpensesnextyeartheprospectoflossesmaybe

unacceptable.Inthatcase,oneanswertorisingratesistolookatshort-durationbondfundsor

short-termCDs.Theseoptionsmaynotofferthehighyieldsoflonger-durationfundorhighyield

bondsorfunds.But,historically,theyhavehadlesspricesensitivitytoratechanges,andthey

typicallyofferacompetitiveyieldrelativetomoneymarketfunds.Inarisinginterest-rate

environment,shortdurationoptionsmayoutperformlonger-durationfunds,inspiteoflower

currentincome.

Learnaboutshort-durationbondstrategies.

3. Goal: Long-term investment and diversification

Oneofthebasictenetsofbuildingaportfolioisthatinvestorswithlargeexposuretothestock

marketshouldbelookingfordiversificationbyinvestinginlonger-duration,high-qualitybond

funds,includingTreasurybondsandcertainmunicipalbonds.Thesefundsmayperformwellwhen

interestratesarefalling,ofteninresponsetoadisappointingeconomicenvironmentorother

marketrisksthatwillhurtstocks.Thetheorythatbondreturnscanhelpoffsetstocklosseshas

beenproventimeandagain(seechartbelow).Thequestionfacinginvestorsnowis,couldthis

timebedifferent?

SomemarketobserversbelievethattheFedseconomicstimulusmeasureshavebeendrivingbond

priceshigherwithlowerratesandsupportinghigherstockpricesbymakingthecostofcapital

lowerforcorporationsanddrivingmoresharerepurchasesanddividendpayouts.Becauseofthe

Fedsunprecedentedinvolvement,thenormaldynamicsofstocksandbondsmaybeoutofwhack,

andsomepeoplebelievebothstocksandbondscouldfallastheFedwithdrawssupport.An

additionalconcernisthatinvestorswillmakeamassexodusfromthebondmarket,causingprices

tocrashthoughwedonotsubscribetothattheory.

11/16/13 Bond strategies for today's markets

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*Asimultaneouschangeininterestratesacrossthebondyieldcurve.Thishypotheticalexampleisanapproximationthatassumesinterest-ratechangeswillalwayshavethesameimpactonbondprices,thoughthatisnotguaranteed;weassumethedurationforthesix-monthbondsand10-yearbondsinthisexampletobe0.38and8.87,respectively.Durationmeasuresthepercentagechangeinpricewithrespecttoachangeinyield.

Eventhisyear,stocksandbondshavemaintainedtheirtraditionalrelationships.Stockreturns

havefaroutpacedbonds,butwhenconcernsaboutmilitaryinvolvementinSyriasurfacedinthe

fallof2013,bondsralliedasstocksstumbled.

Nooneknowsforsureifthetraditionalrelationshipbetweenstocksandbondswillholdduring

thiscycle,saysPotenza.Butwethinktherearegoodreasonsforbondinterestratestostay

relativelylow,includingtheFedsclearintentiontoremainaccommodativefortheforeseeable

future,theslowpaceofglobaleconomicrecovery,anddemographicchangesdrivingdemandfor

incomeproducts.Theprocesswilllikelybepunctuatedwithbustsofvolatility,butagradualriseisourbase-casescenario.

In periods when stocks fell, bonds have typically risen in price

Researchinvestment-gradebondfundsorsearchforindividualmunicipalbonds.

4. Goal: Investing for a goal with a specific timeline

Defined-maturityfundsandindividualbondsofferinvestorstheabilitytoinvestoveraspecifictimehorizonforexample,tofundcollegeorretirement

expensesinaspecificyear.Thisinvestmentstrategyismeanttobalanceinterest-rateandreinvestmentrisk,andtoreducevolatilityandinterest-rate

exposureifthebondorfundisheldtoitstargetmaturity.Inaddition,investinginindividualmunicipalbondsormunicipalbonddefined-maturityfundscan

offertaxadvantages.

Soforinstance,letssayyouareinvestingforyourchildscollegeeducation,whichwillstartinsixyears.Youwanttomakesurethatinterest-ratechanges

dontthreatenyourinvestment,butarelookingtoearnsomereturnonyourmoneytohelppaythebills.Youcouldinvestinadefined-maturityfundorin

individualbondswithamaturitydateof2019andholdyourinvestmenttomaturity.Pricevolatilitywilldeclineasyouapproach2019,and,nomatterwhat

happenstorates,youshouldgetyourprincipalbackatmaturity(assumingtherearenodefaults).

Learnmoreaboutdefinedmaturitybondfundsandbondladders.

5. Goal: A balance of income, diversification, and volatility

Manybondinvestorsseekabalancedmixofthefactorslistedabove:incomegeneration,principalstability,anddiversification.Abroadlydiversifiedbond

portfoliothatincludesexposuretoavarietyofcreditqualitiesandmaturitiesmaysuitsuchpurposeswell.Broadlydiversifiedfundshavetheabilityto

investinawidevarietyofsectors,providingflexibilitytoseekattractivecombinationsofriskandreturn.Relativetoalong-durationgovernmentbondfund,

abroadbondmarketfundmayprovideslightlylessportfoliodiversificationbenefit,butgeneratehighercurrentincomeandgreaterresiliencetorising

interestrates.AgoodexampleistheFidelityTotalBondfund,illustratedbelow.

Learnmoreaboutbroadlydiversifiedfundsorcreateyourowndiverseportfolioofindividualbonds.

Broad diversification: A sample

Asanexampleofbroaddiversification,FidelityTotalBondFundhasamixwithmoreriskthanFidelityInvestmentGradeBondFundbutwithhigheryield

potential.

11/16/13 Bond strategies for today's markets

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What it all means

Thebottomline:Thereisnoone-size-fits-allstrategyforfixedincomeinvestors.Considerfirstwhatyourindividualgoals,risktolerance,andtimelineare.

Thenusetheguidelinesabovetocomeupwithastrategythatworksforyou.

Learn more

ReviewyourbondholdingswithourFixedIncomeAnalysisTool.

Beforeinvesting,considerthefundsinvestmentobjectives,risks,charges,andexpenses.ContactFidelityforaprospectusor,ifavailable,asummaryprospectuscontainingthisinformation.Readitcarefully.

AswithallyourinvestmentsthroughFidelity,youmustmakeyourowndeterminationwhetheraninvestmentinanyparticularsecurityorsecuritiesisconsistentwithyourinvestmentobjectives,risktolerance,financialsituation,andyourevaluationofthesecurity.Fidelityisnotrecommendingorendorsingtheseinvestmentsbymakingthemavailabletoitscustomers.

ViewsexpressedareasofNovember12,2013,andmaychangebasedonmarketandotherconditions.TheopinionsprovidedarethoseofthespeakersandnotnecessarilythoseofFidelityInvestments.AswithallyourinvestmentsthroughFidelity,youmustmakeyourowndeterminationastowhetheraninvestmentinanyparticularsecurityorsecuritiesisconsistentwithyourinvestmentobjectives,risktolerance,financialsituation,andyourevaluationofthesecurity.Consultyourtaxorfinancialadviserforinformationconcerningyourspecificsituation.

Neitherdiversificationnorassetallocationensuresaprofitorguaranteesagainstloss.

Ingeneral,thebondmarketisvolatile,andfixedincomesecuritiescarryinterestraterisk.(Asinterestratesrise,bondpricesusuallyfall,andviceversa.Thiseffectisusuallymorepronouncedforlonger-termsecurities.)Fixedincomesecuritiesalsocarryinflationriskandcreditanddefaultrisksforbothissuersandcounterparties.Unlikeindividualbonds,mostbondfundsdonothaveamaturitydate,soholdingthemuntilmaturitytoavoidlossescausedbypricevolatilityisnotpossible.Lower-qualitydebtsecuritiesinvolvegreaterriskofdefaultorpricechangesduetopotentialchangesinthecreditqualityoftheissuer.

Anyfixedincomesecuritysoldorredeemedpriortomaturitymaybesubjecttoasubstantialgainorloss.Increasesinrealinterestratescancausethepriceofinflation-protecteddebtsecuritiestodecrease.

InterestincomegeneratedbyTreasurybondsandcertainsecuritiesissuedbyU.S.territories,possessions,agencies,andinstrumentalitiesisgenerallyexemptfromstateincometaxbutisgenerallysubjecttofederalincomeandalternativeminimumtaxesandmaybesubjecttostatealternativeminimumtaxes.

Foreignsecuritiesaresubjecttointerestrate,currencyexchangerate,economic,andpoliticalrisks,allofwhicharemagnifiedinemergingmarkets.Theserisksareparticularlysignificantforfundsthatfocusonasinglecountryorregion.

Indexesareunmanagedandyoucannotinvestdirectlyinanindex.

Creditratingsareforward-lookingopinionsaboutcreditrisk.Standard&Poorscreditratingsexpresstheagencysopinionabouttheabilityandwillingnessofanissuer,suchasacorporationorstateorcitygovernment,tomeetitsfinancialobligationsinfullandontime.

Creditratingscanalsospeaktothecreditqualityofanindividualdebtissue,suchasacorporatenote,amunicipalbond,oramortgage-backedsecurity,andtherelativelikelihoodthattheissuemaydefault.

AAAExtremelystrongcapacitytomeetfinancialcommitments.HighestRating.AAVerystrongcapacitytomeetfinancialcommitments.AStrongcapacitytomeetfinancialcommitments,butsomewhatsusceptibletoadverseeconomicconditionsandchangesincircumstances.BBBAdequatecapacitytomeetfinancialcommitments,butmoresubjecttoadverseeconomicconditions.BBBConsideredlowestinvestmentgradebymarketparticipants.BB+Consideredhighestspeculativegradebymarketparticipants.BBLessvulnerableinthenear-termbutfacesmajorongoinguncertaintiestoadversebusiness,financialandeconomicconditions.BMorevulnerabletoadversebusiness,financial,andeconomicconditionsbutcurrentlyhasthecapacitytomeetfinancialcommitments.CCCCurrentlyvulnerableanddependentonfavorablebusiness,financial,andeconomicconditionstomeetfinancialcommitments.CCCurrentlyhighlyvulnerable.CCurrentlyhighlyvulnerableobligationsandotherdefinedcircumstances.DPaymentdefaultonfinancialcommitments.

BarclaysCapitalU.S.35YearGovernmentBondIndexisamarketvalueweightedindexofU.S.governmentfixed-ratedebtissueswithmaturitiesbetweenthreeandfiveyears.

BarclaysCapitalAggregateBondIndexisamarketvalueweightedindexofinvestment-gradefixed-ratedebtissues,includinggovernment,corporate,asset-backed,andmortgage-backedsecurities,withmaturitiesofoneyearormore.

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BarclaysCapitalInvestmentGradeCorporateBondIndexisanunmanagedmarketvalueweightedindexofinvestment-gradecorporatefixed-ratedebtissueswithmaturitiesofoneyearormore.

BarclaysCapitalU.S.3-MonthTreasuryBellwetherIndexisamarketvalueweightedindexofinvestment-gradefixed-ratepublicobligationsoftheU.S.Treasurywithmaturitiesofthreemonths,excludingzerocouponstrips.

TheS&P500Indexisamarketcapitalizationweightedindexof500commonstockschosenformarketsize,liquidity,andindustrygrouprepresentationtorepresentU.S.equityperformance.

IbbotsonAssociatesLong-TermGovernmentBondIndexismeasuredusingaone-bondportfoliowithamaturitynear20years.

TheIbbotsonU.S.Long-TermCorporateBondIndexisamarketvalueweightedindexthatmeasurestheperformanceoflong-termU.S.corporatebonds.

BankofAmericaMerrillLynchHighYieldMasterIndextrackstheperformanceofbelow-investment-gradeU.S.dollardenominatedcorporatebondspubliclyissuedintheU.S.domesticmarket.

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