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A year ago, bonds and bond funds were for losers.

For the 12 months to May 31, 2018, the FTSE Canada Universe Bond Index was down 1 per cent on a total return basis (bond interest combined with changes in bond prices). Interest rates were rising at the time, and the outlook for bonds and bond funds was negative. And so you commonly heard investors talk about carving off some of their portfolio exposure to bonds and allocating it to stocks, cash or other things.

The 12 months ended May 31, 2019, offer a view on how this seemingly savvy bit of portfolio tinkering can backfire.

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With bond yields falling hard, the price of bonds and bond exchange-traded funds has been rising (prices and yields move in opposite directions). As a result, the FTSE Canada Universe Bond Index was up 7 per cent on a total return basis for the 12 months through May 31. Even more impressive is the FTSE Canada Long Term Bond Index, up 10.2 per cent for the same period.

The S&P/TSX Composite Index made 3 per cent on a total return basis for the 12 months to May 31, while cash returns would be in the range of between 1 per cent and 1.5 per cent. Out of the blue, bonds have become one of the strongest asset classes this year.

A shifting interest rate outlook is the reason. The economic momentum that drove expectations of higher rates 12 months ago has waned, and there’s growing concern now about an economic downturn. Bond yields are falling as a result, and that’s good for the price of bonds and bond funds.

Bonds in 2019 are doing exactly what they’re supposed to – hedge a portfolio against economic worries. Bonds are also a hedge against stock market declines, which are a risk if concern about the economy and corporate profitability grows.

A lot of the time, you won’t like the way bonds perform in your portfolio. Stick with them because conditions can change in a hurry. The changing fortunes for bonds in the past 12 months prove it.

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