Boring bonds: You only need them when you really need them!
Published: 27th March 2020
Bonds are often described as boring. Over the past few years, you will have heard us talk about bonds – in our blogs and Investment Committee Minutes – as the defensive assets in investment portfolios.
Through periods of bull markets (where global stock markets are making healthy returns) bonds tend to provide a lower return. However, as recently as 2018 and 2019, there’s been much speculation about when investors should get out of bonds, in anticipation of rising interest rates.
This has caused investors and fund managers to question the continued role of bonds in an investment portfolio.
So, what are bonds?
Bond markets can be confusing and there are many different types.
Bonds are loans to governments and companies. The loans are issued for different periods of time and they pay a ‘coupon’ – a rate of interest on the loan. If you hold the bond until the end of the term, the investor gets their money back. However, at any point during the term, bonds can be traded on the secondary bond market. Common factors that impact the price of a bond are inflation and interest rates.
Why is this relevant right now?
Bond markets have been impacted by the recent global uncertainty. However, the defensive allocation of our model portfolios has performed as we would expect during the current period of market volatility.
To re-cap, the defensive allocation of our model portfolios consists of mainly high-quality, short-dated bonds, with some short to medium duration UK inflation linked government bonds.
Inflation linked bonds aren’t covered in the below chart, but collectively our bonds, or ‘Defensive 0’ as we call it, sit in the green area, outside of the scary looking losses in yellow and red.
The above chart looks at asset class returns from 21st February 2020 (around the peak in stock markets) to 20th March 2020. From left to right, the first 18 markers are different types of bonds (and that’s not all of them!) – you can see the varying returns over the period. Clearly, certain bonds shouldn’t be treated as defensive assets during times of market stress such as now.
For instance, exposure to higher yielding bonds (Global HY, B – ALL, highlighted red in the above chart), would mean your losses will have been worse than exposure to emerging equity markets!
So, bonds do have a vital role in the construction of diversified investment portfolios. They help minimise potential losses during the toughest periods whilst allowing you to remain fully invested and capture all of the recovery in equity markets when the time comes.
So, that’s the low down on why we need bonds – it’s at times like these that boring is good!
As always, we’re here to help. If you any questions or would like to chat please get in touch.
Past performance can’t guarantee what investments will do in the future. The value of a portfolio can go down as well as up, so there’s a chance you’d get back less than you put in.