Bonds are the parachutes of the investment world; they have offered safe, stable income and their prices generally go up when everything else goes down, giving them a nice defensive quality in portfolios. Falling interest rates are the wind that keeps the parachute open and the greater the duration (interest rate sensitivity), the softer the landing. However, the very factor that makes them such an attractive hedge against a deteriorating economy and equity market transforms the parachute into a source of instability in a zero interest rate environment.
The traditional toggle between stocks and bonds to dial up and down risk in a portfolio has been rendered ineffective. Today, migrating into strategies that deliver stable returns and principal safety yet have performance drivers that are largely independent of interest rate risk (and credit spreads) is an essential part of building a defensive portfolio.
This is an excerpt from our article “What color is your parachute?” published January 31, 2012