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Fixed income strategists were largely bearish for 2016, due to historically low yields and the prospect of rising interest rates. But the path was rockier than expected, putting bond investors through the wringer.

For example, “if you just piled into bonds in the last quarter of 2016, you’d be sitting on a loss,” says Stephen Lingard, senior vice-president and portfolio manager for Franklin Templeton Solutions in Toronto.

If you look at the iShares DEX Universe Bond Index Fund, which tracks the performance of the Canadian bond market, he explains, it was down nearly 3.5% in the fourth quarter, if you reinvested dividends. That compares to the first three quarters of 2016, when the fund was up almost 5%, if you reinvested dividends, he adds. For the year, the return was about 1.3%, compared to stronger performance in 2014 and 2015.

Overall, due to growth and inflation trends and to bond market asymmetry—in this case, where there was far more downside than upside for investors—there was “higher magnitude for risk of loss with minimal upside in terms of return,” says Lingard.

Lingard remains bearish on fixed income for 2017, noting, “We’re not loading up on bonds.”

Read: The trouble with corporate bonds issued in foreign currencies

At some point, “higher interest rates will eventually induce the next recession, and that will obviously weigh on inflation expectations and growth, and that will be the period to buy back bonds,” he says. “But I don’t think that’s a 2017 story,” he adds, even though in the longer run, rising interest rates could “cause the next recession, given today’s high debt loads.”

Read: High yield critics off the mark for 2017

Last year’s jumpy bond performance shows it pays to position for negative bond surprises. Here’s a look at how Lingard’s 2016 fixed income prediction and positioning played out.

2016 prediction: Rates would creep up, creating a more a bearish environment for bonds

Last year, “we thought yields wouldn’t go up very significantly because of weak ongoing economic growth and weak inflation, and central banks that were very supportive,” says Lingard, whose call was for the U.S. 10-year Treasury rate to rise to 2.5% by the end of 2016.

He expected “the same Steady Eddie growth in North America, with maybe a little bit more traction in the economy and a little bit more inflation.” He also called for “limited ability for yields to fall further,” given central banks were—and continue to be—“fairly exhausted.”

Read: Hike gave Fed ‘more breathing room,’ says analyst

He had predicted that, for 2016, “you could be right and make a little bit on bonds, or you could be wrong and lose a lot for very little upside.” Lingard adds: “While we weren’t aggressively positioning portfolios for a bearish view, we built in higher cash and lower duration at the margin.”

ACTUAL OUTCOME: Bonds offered too much volatility for too little upside.

In the early part of 2016, he says, “we took some flak for having a lot of cash.” He and his team had 6% allocated, compared to their usual level of less than 3%—by the end of the year, when the sell-off occurred, he’d reduced his cash pile to around 3% because he bought more bonds, as well as equities, when yields rose and bond prices dropped at the end of the year.

Still, Lingard planned to and did hold shorter duration—of about two-thirds of the duration of the broader market—for the whole year, and that applied to his Canadian, U.S. and international holdings. By doing that, he says, “you still take a loss but less of one than the broad market.”

Read: Don’t overthink default risk

Was the prediction correct?

Yes, but it wasn’t evident until the fourth quarter of 2016, when yields rose and prices dipped dramatically.

U.S. President Donald Trump’s 2016 victory wasn’t the only catalyst for this, says Lingard, but Trump’s win did “add fuel to the fire and push rates up further,” which Lingard hadn’t anticipated. What he did notice was bond yields already rising prior to the fall, a trend that began in September, as global recession fears abated.

Read: Be cautious on international bond risk

By the end of 2016, 10-year Treasurys had exceeded 2.5% and then pulled back, outdoing his forecasted target slightly. Still, earlier in the year, it was hard to imagine that could have happened: heading into July, that rate had reached an unexpected low of around 1.3% due to volatility, and had to subsequently bounce back. Yields in Canada saw a similar journey.

Overall, Lingard had expected that the journey toward a higher 10-year Treasury rate would be smoother. He thought it would be “very gradual throughout 2016, as opposed to inflecting higher in the summer and then completely jumping up after November, as we saw. That surprise caused a bond sell-off at end of the year.”

Given the rocky journey, Lingard was happy with his underweight positioning, and he ended the year with positive returns.

Lessons learned

Lingard is still concerned about bond market asymmetry for 2017. He also forecasts consolidation, but not another situation where yields fall dramatically. He says yields have had a jumpy start this year but that “they’re headed up now.”

He’s remained cautious on bonds, even though he reduced his cash allocation to around 3% at the end of 2016 by bumping up his bond and equity exposure. No matter how volatile markets are, says Lingard, “you can’t abandon bonds altogether. If the equity markets go into a spin, you’re going to be glad you had fixed income.”

Going forward, Lingard expects “more up in yield than down […] over the next year or two in developed markets,” and suggests investors “keep durations short and stay underweight in fixed income.” Latin America is one area that offers fixed income opportunities via government bonds, while there’s also a lot of asymmetry in Europe and Asia when it comes to government bonds.

Read: Institutional investors use ETFs for fixed income, smart beta

What’s driving the bond market?

When it comes to reading the market, portfolio manager Stephen Lingard looks at three things: “expected growth, expected inflation, and [the] term premium, which really is a euphemism for central bank balance-sheet buying.”

Currently, he finds, “bonds are very driven by technicals,” especially since central banks in England, Japan and the eurozone “are still heavily buying bonds to keep yields low [and] try to encourage economic growth and real investment.”

But that will change, he adds, “as central banks begin to back away from exceptional liquidity. You’re going to start to see more volatility in the bond market space and, potentially, higher yields, leading to negative returns [once again].” However, says Lingard, “this will be a good thing for the global economy.”