When we’re chatting with clients, we often get the same flavor of questions about bonds (we would bet if you have exposure to the bond market, you’ve wondered some of these as well…). So we wanted to tackle four key questions we’re hearing a lot right now:
This sounds like a market-timing question, and we don’t believe in timing the market as an investment strategy (mostly because almost no one can do it well and/or consistently for any kind of sustained duration).
Obviously we can’t say for certain what the stock market will or won’t do in the near future, but the last couple of months certainly seem to indicate increased volatility might be a mainstay of our lives for the next year or two.
Bonds are a great counterbalance to diversify your overall portfolio (especially when volatility is high).
To that end, our philosophy at City Different Investments is simple — we take risks when it pays to take those risks.
That means we adjust our exposure in the bond market based on clear risk metrics, not short-term trends. Diversification is one of the most effective ways to manage that risk — and bonds play a crucial role in that.
Let’s break down some specifics, shall we?
We’ve analyzed the correlation between the S&P 500 and our taxable and municipal limited-term separately managed accounts (SMAs) 1. Looking at weekly data from 2008 through early 2025, the numbers show what we expected:
In other words, these bonds help balance a portfolio. When stocks are up, bonds may not match the returns — but when stocks fall, bonds often hold steady or even gain.
More foundationally, though, we believe that the best risk mitigation tool available to investors is true diversification between different asset classes. This philosophy plays out in fixed income along credit quality, sector allocations and yield curve exposure (and it’s why we manage diversified, laddered portfolios).
Money market funds are great for short-term cash needs and emergency savings. But they come with reinvestment risk (meaning their yield fluctuates significantly as interest rates change, and you may not be able to get the rate you’re earning today in the future).
Take the Vanguard Federal Money Market Fund (VMFXX):
Compare that to the Bloomberg Intermediate U.S. Government/Credit Index and Bloomberg Muni 1-10Yr Blend (their yields were more stable over the same period).
The takeaway? Money market funds can be useful, but if you're looking for a more stable income stream over time, bonds are often the better play in our opinion.
Always.
Because bonds often move opposite to stocks, they provide balance in most any market cycle. But not all bonds are created equal. They vary by:
The best choice depends on your goals. But in general, staying diversified within the bond market — just like with stocks — is key. And, the relative value of each fixed income group depends on the risk/reward profile of the other fixed income options.
Put another way, are investors getting paid for the risk each group represents?
We build our bond portfolios around a simple principle: maximize income per unit of risk, with a total return mindset.
Here’s how we determine the best value as we see it:
1. Real Yield (After Inflation)
Real yield = bond yield minus inflation (we use Core PCE, the Fed’s preferred measure).
Looking at Treasury bonds as of January 2025:
The same pattern holds for municipal bonds (to a slightly lesser degree).
That’s why we favor 5-year bonds at the moment — they strike the best balance between income and risk.
5-year bonds have the second best relative real yield but with much less reinvestment risk.
2. Yield Curve Slope
On Jan. 31, 2025, the 2-to-10-year Treasury spread was just 0.34% — far below its long-term average of 1.09%.
The maximum 2-10 spread for this period is +3.40%, the minimum spread is -1.94%, with the median spread landing at +1.21%.
Translation: investors aren’t getting paid enough to take on longer durations (and the concordant risk).
The municipal bond market tells the same story. The slope of 2-10’s on Jan. 31, 2025 is +0.35%; the long-term average is +0.98%; the maximum 2-10 spread for this period is +2.55%; the minimum spread is -0.48%; and the median spread is +0.88%.
When the yield curve is this flat, short-term bonds offer the better deal because you’re not getting paid to take the duration risk (right now, anyway).
3. Income Per Unit of Risk
A 5-year Treasury bond gives you 95% of the income of a 10-year bond — with only 55% of the duration risk (see below for the math:)
In the municipal bond market, the numbers are similar — a 5-year AAA municipal bond delivers 92% of the income of a 10-year bond, but with just 55% of the duration risk.
This kind of risk-adjusted relationship is why we’re overweighting shorter bonds. The long-term average of the relationship is closer to 78% (as opposed to the 55% we’re getting right now), so the 95% and/or 92% income we’re getting vs. the 55% duration risks present attractive value by our way of thinking.
4. Credit
Credit spreads (the extra yield an investor is promised in order to buy lower credit quality securities) are quite narrow right now. As such, investors aren’t getting paid to take that credit risk.
Side note — the recent chaos created by the administration’s waffling on economic policies like federal employment levels, tariffs, and immigration has raised concern for a recession (or a period of prolonged stagflation).
In our view, none of that is conducive to stable (narrow) credit spreads.
Parting Thoughts
Bonds are an important hedge against equity volatility.
Money markets are a great tool for specific tasks, but the reinvestment risk outweighs their attractiveness in the current economic environment.
We feel that it’s always a good time to buy bonds, but you should diversify your fixed income investments like you would your stock portfolio.
And finally, we’re overweighting short-duration bonds in our fixed income SMAs because we’re not getting paid to take duration risk right now.
If you have any questions about our thinking, analysis, or just more general questions about fixed income securities, we’re always willing to speak with you personally.
1 We will use our taxable and municipal limited-term SMA’s in all discussions. We have run correlation analysis for the S&P 500 index and our taxable and municipal limited term SMA benchmarks (Bloomberg Intermediate U.S. Government/Credit index and Bloomberg Muni 1-10Yr Blend (1-12) Total Return Index). We used the first differences method (The "first differences method" in correlation analysis refers to a technique where you calculate the difference between consecutive data points in a time series for both variables before performing a correlation analysis). The data was broken down into consecutive 90-day segments from 6/6/2008 to 2/21/2025 (weekly observations). We calculated the correlation coefficient for each 90-day segment and then averaged all segments. The taxable benchmark had a long-term correlation coefficient of 0.074 (last 90-day segment correlation coefficient of -0.011). The municipal limited term benchmark had a long-term correlation coefficient of -0.047 (last 90-day segment correlation coefficient -0.004).
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