The primary objective of the bond portion of a portfolio is capital preservation.
For many investors, having some high-quality fixed income exposure in a financial portfolio is like eating your vegetables. A large benefit of high-quality bonds is that during times of equity market stress they typically hold their value or even appreciate, at which time they can be partially sold to buy stocks at depressed prices as part of a discipline of regularly rebalancing a portfolio to its target allocation.
Much like with stocks, we can put together a highly diversified bond portfolio with just a few line items of index funds while maintaining the flexibility to tilt our exposures to the corners of the bond market we view most favorably.
While we do not rule it out entirely, we typically do not invest in individual bonds. Having said that, as with individual stocks, individual bonds sometimes reach bargain purchase prices, but we feel our time is more productively spent attempting to uncover bargain purchases in the equity market.
As with stocks, we are willing to hold cash in a bond allocation, but at a maximum of 10%. There are 3 reasons for having a lower max cash position in bonds than stocks:
First, with plenty of exceptions, stocks tend to get attractive or unattractive together. By contrast, different segments of the bond market tend to zig when others are zagging. For instance, when corporate bonds declined in the spring of 2020, risk free Treasury bonds were experiencing price increases. Point being, there is embedded “dry powder” in a bond portfolio relative to a stock portfolio.
Second, while the presence or absence of bargain stock purchases drives the intra-stock-allocation cash balance, we do not buy individual bond issues with any regularity, instead gaining our exposure via broad segment index funds. This naturally leads to our investment operations in bonds being driven largely by macro considerations. As discussed on the Stocks Tab, it is our belief that one can more easily slip into market timing when focusing more on the macro than the micro.
Last, stocks are typically much more volatile than bonds. Therefore, it can be beneficial to build cash when market conditions are more ebullient and deploy cash when investment conditions become depressed. With bonds it is usually best to stay nearer the target allocation that fits your risk tolerance and receive your interest.