OBLIGATIONS have worked so well for so long that it can be hard to imagine your portfolio without them. Yet, after the worst year for global bond markets in decades, there are real concerns about their outlook for the future.
The biggest threat they face is inflation. As prices rise, they erode the value of the fixed income payments you receive on a bond. If you earn 3% interest on a bond but inflation is 5%, you are actually losing money in “real”, inflation-adjusted terms.
Rising inflation means rising interest rates, which in turn means rising bond yields. Because bond prices are inversely related to yields, this is bad news for bond prices.
Add all that up and you have a whole new market environment that bodes ill for bonds.
But that doesn’t mean bonds are worthless now. Judging them on their returns only tells half the story. For most people, bonds are primarily used to protect their portfolios, not to generate exceptional returns. Their performance is generally different from that of stocks, which means that when stock prices fall, investors who hold both bonds and stocks are spared.
It is for this reason that the simple mantra of a 60/40 portfolio split between stocks and bonds has worked well for many investors. 60% in stocks meant you were exposed to their rewards, while 40% in bonds tempered the excesses.
Unfortunately, the links are starting to struggle here as well. Part of the way they protected a portfolio was due to their “negative correlation” with stocks, that is, by performing different performance. It is not known if this negative correlation still holds. Inflation could hurt both asset classes at the same time, while rising interest rates threaten some stocks, whose earnings are expected over the long term, in much the same way as bonds.
Nonetheless, bonds will always provide some sort of buffer. They aren’t as volatile as stocks, which means you’re less likely to lose as much on your bonds as you are on your stocks.
In this context, obligations still make sense. But do they justify the 40% weighting they occupy in a typical 60/40 portfolio? Maybe not. It’s a big part of your portfolio to give in at minimal returns, especially if bonds start to move in line with stocks.
Maybe now is the time to take a look at your bond exposure and maybe top it up with inflation-linked bonds. The ASI Global Inflation-Linked Bond Fund, for example, is designed to rise in value as inflation rises, although it will fall if real interest rates rise.
Also consider some alternative asset classes. The classic is gold, which is supposed to retain its value (unlike bonds) thanks to rising inflation. My colleague Tom Stevenson has included the Ninety One Global Gold Fund among his four fund choices for 2022. Other alternative investments, such as infrastructure and real estate, will also help diversify your portfolio.
Changing your portfolio allocations can be intimidating, but the simple investing rules that worked no longer apply.
To help you navigate these quicksand, you can check out Fidelity’s latest Quarterly Investment Insights, which you can find here tomorrow. There you will find our take on all major asset classes and regions, as well as commentary on the direction of the markets over the coming months.
OBLIGATIONS have worked so well for so long that it can be hard to imagine your portfolio without them. Yet, after the worst year for global bond markets in decades, there are real concerns about their outlook for the future.
The biggest threat they face is inflation. As prices rise, they erode the value of the fixed income payments you receive on a bond. If you earn 3% interest on a bond but inflation is 5%, you are actually losing money in “real”, inflation-adjusted terms.
Rising inflation means rising interest rates, which in turn means rising bond yields. Because bond prices are inversely related to yields, this is bad news for bond prices.
Add all that up and you have a whole new market environment that bodes ill for bonds.
But that doesn’t mean bonds are worthless now. Judging them on their returns only tells half the story. For most people, bonds are primarily used to protect their portfolios, not to generate exceptional returns. Their performance is generally different from that of stocks, which means that when stock prices fall, investors who hold both bonds and stocks are spared.
It is for this reason that the simple mantra of a 60/40 portfolio split between stocks and bonds has worked well for many investors. 60% in stocks meant you were exposed to their rewards, while 40% in bonds tempered the excesses.
Unfortunately, the links are starting to struggle here as well. Part of the way they protected a portfolio was due to their “negative correlation” with stocks, that is, by performing different performance. It is not known if this negative correlation still holds. Inflation could hurt both asset classes at the same time, while rising interest rates threaten some stocks, whose earnings are expected over the long term, in much the same way as bonds.
Nonetheless, bonds will always provide some sort of buffer. They aren’t as volatile as stocks, which means you’re less likely to lose as much on your bonds as you are on your stocks.
In this context, obligations still make sense. But do they justify the 40% weighting they occupy in a typical 60/40 portfolio? Maybe not. It’s a big part of your portfolio to give in at minimal returns, especially if bonds start to move in line with stocks.
Maybe now is the time to take a look at your bond exposure and maybe top it up with inflation-linked bonds. The ASI Global Inflation-Linked Bond Fund, for example, is designed to rise in value as inflation rises, although it will fall if real interest rates rise.
Also consider some alternative asset classes. The classic is gold, which is supposed to retain its value (unlike bonds) thanks to rising inflation. My colleague Tom Stevenson has included the Ninety One Global Gold Fund among his four fund choices for 2022. Other alternative investments, such as infrastructure and real estate, will also help diversify your portfolio.
Changing your portfolio allocations can be intimidating, but the simple investing rules that worked no longer apply.
To help you navigate these quicksand, you can check out Fidelity’s latest Quarterly Investment Insights, which you can find here tomorrow. There you will find our take on all major asset classes and regions, as well as commentary on the direction of the markets over the coming months.