It has been discerned that investors prefer to include bonds in their portfolios for two major reasons: the benefit of a fixed return and the limited volatility of bond prices.
Even with low yield bonds, investors get the benefit of diversification of the portfolio. However, since the return is too low, owning a meaningful allocation to investment-grade bonds might be difficult.
As such, higher-yield bond substitutes can make for better options. And in this post, we’ve compiled some bond substitutes that you might find pretty valuable. We won’t say they’re perfect, but they do have their advantages over investment-grade corporate and municipal bonds.
So, without further do, let’s take a look at a few of them.
It’s aptly said that real gold never loses its shine!
Gold can be a worthwhile bond substitute. While it doesn’t pay investors any income (like an interest), it has the advantage of appreciating over time. Besides, gold prices aren’t directly correlated with stock prices, and that offers a significant diversification to an investor’s portfolio. In a scenario like today, where real bond yields often dip to extreme lows, gold can very well rise in price and give you much better returns.
Investors who own stocks and are aiming to reduce their fixed income exposure are usually advised to consider gold as a bond alternative.
Inflation protected bonds
You will find several inflation-protected bonds in the market, and the most common is TIPS (Treasury Inflation-Protected Securities). Since its value steps up with the consumer price index, you get quite a bit of inflation protection with this bond. The catch here is that you get the maximum benefit when the inflation expectations are high and the least when inflation expectations are falling quickly.
Business Development Companies (BDCs)
These are the investment companies that pay out their earnings to investors while they buy leveraged loans. To have an interest rate that’s more than what’s being offered by investment-grade bonds, companies that don’t have a strong balance sheet end up issuing leveraged loans.
What’s the benefit here? It’s that if the company goes bankrupt, leveraged loans generally recover more than bonds in bankruptcy. If a company is bankrupt, it’s the leveraged loans and not the bonds that receive the capital stack’s priority.
Wrapping it up
All the above-mentioned bond substitutes work slightly differently as they have varied liquidity and volatility. Unfortunately, there’s no single perfect replacement for government or corporate bonds. As such, employing a mix of bond substitutes in your investment portfolio along with some municipal or corporate bonds might be the best option.
If you’re ready to take risks, it’s worth going for these bond alternatives. However, if you have a compressed investing time horizon with a low tolerance for risk, the best thing will be to minimize the use of bond substitutes.