Bonds have been synonymous with boredom since the 2008 financial crisis sent interest rates to near-zero for decades. But in 2021, COVID-driven economic stimulus and supply chain disruptions sent inflation soaring. And soon after, interest rates began their rapid ascent, sending Treasury rates above 5% and making bonds suddenly competitive with stocks.
The public began taking notice with Series I bonds, which saw their risk-free interest rates soar into the double digits. Soon after, bank accounts and certificates of deposit began experiencing dramatic interest rate increases. And now, many investors have become accustomed to 5%+ yields for their idle cash and even more for their fixed income.
In this article, we’ll look at why the sharp increase in interest rates could prompt investors to move into fixed income, particularly as interest rates start to decline.
Retail Interest on the Rise
Retail investing is typically a function of market strength. For example, retail orders hit 14% of daily share volume in 2020 before dipping to 7% by late 2022 and resurging to 11% in 2023, according to Morgan Stanley. So, not surprisingly, higher fixed income interest rates have led to retail interest in the thus-far-nascent bond markets.
The CAPE ratio remains elevated for the S&P 500 index, suggesting that equities may be overvalued relative to their past. Source: Multpl
The case for bonds is further supported by lofty equity valuations. While it’s true the equity market regained its shine in 2023, the S&P 500 cyclically adjusted price-earnings ratio stands at 32.57, which is sharply higher than their 16-17x averages. Bonds, on the other hand, offer a safe-haven asset class with relatively attractive risk-adjusted returns.
Investors may also increasingly seek a way to preserve high interest rates for their idle cash. As savings interest rates and CD rates move lower over the coming year, bonds could offer the only 5%+ interest rates that they’ve become accustomed to. The problem is democratizing access to these conventionally expensive and illiquid securities.
The Fractionalization of Bonds
Robinhood and other fractional investing platforms have helped democratize access to equity markets by making shares more affordable. But until recently, fixed income investments have been plagued with $1,000 to $10,000 minimums, making it difficult for small-scale investors to build a diversified portfolio for less than tens of thousands of dollars.
Fintech companies are trying to change these dynamics to meet growing retail demand. For example, Apex Fintech Solutions launched a new fixed income investing platform. They enable anyone to purchase individual government, municipal, and corporate bonds on a fractional basis, democratizing access to the previously unreachable fixed income world.
Online brokerage platforms like Public are also offering investors the ability to invest in $100 slices of government and corporate bonds. According to Reuters, the company plans to add municipal bonds this year and eventually lower the minimum to just $10. This would make individual corporate bonds just as accessible as stocks for the everyday investor.
Bonds vs. Bond ETFs
Bond ETFs have been the historical go-to for individual investors seeking exposure to the fixed income markets. While these funds offer instant diversification and professional management, they involve management fees, and their value fluctuates with the market. For example, the recent rise in interest rates has sent bond ETF prices sharply lower over the past few years.
On the other hand, individual bonds provide a reliable income stream and a predictable value at maturity, making it easier to plan. You can also compute your own cost basis by looking at the purchase price and any amortization of premiums or discounts, which simplifies tax planning. You can also build bond ladders and other strategies suited to your specific requirements.
Of course, the challenge is building and managing the portfolio. As with investors purchasing individual stocks, building the appropriate bond portfolio, and taking the time to rebalance it, requires a significant time investment. And a failure to properly manage the portfolio could lead to excessive risk-taking or sub-par returns over the long term.
What’s Next?
Interest rates are likely to fall in 2024 with the Federal Reserve planning at least two rate cuts and the market predicting even more. While that could dampen interest in fixed income, investors could also turn to these platforms to preserve the high interest rates they are losing from bank accounts, CDs, and other short-term liquidity instruments.
More broadly, fractional investing platforms could enable investors to take investing into their own hands, buying both fractional equities and bonds rather than funds. And, at the same time, it could help increase liquidity in the fixed income markets, providing better price discovery and lowering costs for everyone if trading becomes widespread.
