Volatility in the banking sector has forced investors to reevaluate their exposure to the financial services sector—not to mention their personal banking needs.
A string of sudden bank failures in the United States that began with the collapse of Silicon Valley Bank in March shone a negative spotlight on depositor insurance protection and the Federal Reserve’s uneven approach to regulation. “Following Silicon Valley Bank’s failure, we must strengthen the Federal Reserve’s supervision and regulation, based on what we have learned,” said Fed vice chair for supervision Michael Barr in a 114-page post-mortem report.
According to investment manager Pimco, high-profile banking failures in the United States have “raised the prospect of a significant tightening of credit conditions,” which could lead to a more imminent and deeper recession. Against this backdrop, investment-grade bonds can serve the dual mandate of income generation and protection against downside risks to the economy.
Be sure to check our Regional Banking page to explore more stocks.
Risk of Recession Grows
The International Monetary Fund (IMF) recently warned of a sharp slowdown in economic growth over the next two years, especially in advanced markets. Citing financial sector turmoil, stubbornly high inflation, and the ongoing impact of the Russo-Ukrainian war, the IMF forecast U.S. economic growth to slow to just 1.6% in 2023 and 1.1% in 2024. Advanced economies are expected to grow 1.3% in 2023 and 1.4% in 2024.
While the IMF stopped short of calling for an outright recession, Pimco analysts said the rising cost of capital and fears of deposit flights from smaller and midsize banks could push the U.S. economy into a mild contraction this year. “Monetary policy works through lags,” Pimco said, referring to the Federal Reserve’s aggressive rate hikes since March 2022, culminating in another 25 basis-point hike in May 2023. “This episode reveals that tighter financial conditions are having an increasing effect on the banking sector, and by extension on economic activity, demand, and eventually inflation.”
According to Pimco, deposit outflows, shrinking margins, and more stringent regulations are expected to limit credit growth and dampen consumption.
Tiding Over Risk With Bonds
2022 was a difficult year for fixed income, as bonds struggled to live up to their traditional qualities of capital preservation and diversification. In Pimco’s analysis, that script is about to flip as bonds become more attractive in the face of deteriorating economic growth and banking sector volatility.
The investment manager said there is opportunity in short-term, cash-equivalent investments, given today’s elevated yields, as well as longer-term bonds. Focusing on high-quality, more liquid investments while avoiding lower-rated corporate credit should provide income-generating opportunities and limit exposure to the impact of tighter monetary policy.
Here are the lists of bond funds, which are sorted by YTD return.
Long-Term Bonds
| Name | Ticker | Type | Active? | AUM | YTD Ret (%) | Expense |
| iShares Core 10+ Year USD Bond ETF | ILTB | ETF | No | $0.23 bn | 5.4% | 0.06% |
| Vanguard Long-Term Treasury Idx Admiral | VLGSX | Mutual Fund | No | $7.32 bn | 5.3% | 0.07% |
| Fidelity® SAI Long-Term Treasury Bd Idx | FBLTX | Mutual Funds | No | $5.54 bn | 5.1% | 0.03% |
| SPDR® Portfolio Long Term Treasury ETF | SPTL | ETF | No | $5.46 Bn | 5% | 0.06% |
| iShares 20+ Year Treasury Bond ETF | TLT | ETF | No | $20.6 bn | 4.9% | 0.15% |
| PIMCO Long-Term US Government A | PFGAX | Mutual Fund | Yes | $0.64 bn | 4.5% | 0.92% |
| Vanguard Long-Term Investment-Grade Inv | VWESX | Mutual Fund | Yes | $17.1 bn | 3.6% | 0.22% |
Be sure to explore U.S. Long-Term Bonds page to check more investment options.
Short-Term Bonds
| Name | Ticker | Type | Active? | AUM | YTD Ret (%) | Expense |
| Vanguard Short-Term Bond ETF | BSV | ETF | No | $70.5 bn | 2.4% | 0.04% |
| Vanguard Short-Term Corporate Bond ETF | VCSH | ETF | No | $47.9 bn | 2.2% | 0.04% |
| Vanguard Short-Term Bond Index Inv | VBISX | Mutual Fund | No | $70.5 bn | 1.9% | 0.15% |
| iShares Ultra Short-Term Bond ETF | ICSH | ETF | Yes | $6.36 bn | 1.8% | 0.08% |
| PGIM Short-Term Corporate Bond | VSTBX | Mutual Fund | Yes | $47.9 bn | 1.6% | 0.05% |
| iShares Short Treasury Bond ETF | SHV | ETF | No | $19.8 bn | 1.5% | 0.15% |
| Fidelity® Conservative Income Bond Instl | FCNVX | Mutual Fund | Yes | $6.2 bn | 0.2% | 0.25% |
You can also check our U.S. Short-Term Bonds page and U.S. Ultra Short-Term Bonds page to browse through other options.
The Bottom Line
Bond funds registered record inflows to start the year, with investors drawn to higher yields and the asset class’ historical outperformance during recessionary periods.
As seen in the previous section bond funds across different maturities continue to post decent performances this year till date. For instance:
- ILTB, which tracks government, corporate, and emerging market bonds that mature in 10 years or more, has returned 5.4% year-to-date. VWESX, which has a more narrow focus on long-term investment-grade corporate bonds also performed well.
- Bonds with shorter maturities, such as the SHV and ICSH, have also provided positive returns.
- Ultra-conservative strategies, such as that provided by FCNVX, are also considered a good diversifier for investors concerned with capital preservation.
