high-quality bonds

High Quality Bonds in the Spotlight

There is an old adage in the investment world that ‘diversification is always having to say you are sorry’, as there is usually one (or more) parts of the portfolio that is a bit disappointing.  Every asset class has its day in the spotlight, for good or for bad, at some point.  

Over the past couple of years, shorter-dated, high-quality bonds that constitute strong defensive assets have delivered low returns and have had a finger pointed at them, by some.  Bond yields have been at historical lows, with yields on 5-year UK government gilts at or below 1% for the past three years.  Today they stand at around 0.2% and that is before the impact of inflation.  It is understandable that investors find low yields frustrating, but one needs to look at the bigger picture.  Bonds sit in long-term portfolios predominantly to provide some stability at times of equity market turmoil.

In the face of these low yields, investors have had two straight choices: accept the fact and stoically maintain the quality of their bonds; or go in search of yield by owning lower credit quality bonds and/or bonds of longer maturity.  We know that many have been tempted by the latter strategy.  We have stuck to the former to defend the portfolio at times of equity market turmoil such as this.  Remember that the lower the credit quality of bonds, the more they act like equities.

We think of yield-driven bond strategies – particularly high yield bonds – as akin to picking up pennies in front of a steamroller, which works nicely until you trip over.  The chart below looks at the performance of different types of bonds since the equity markets began to fall in February this year.  

It reveals that high-quality bonds have more or less held their value, doing the job asked of them.  As one moves down the credit spectrum to lower quality companies, returns become increasingly negative.  Owning these lower quality bonds, but with longer maturities, simply magnifies these falls (heading from left to right in the chart).  As it has always done, scared money runs from higher risks (including the possibility of default on bonds from less healthy companies) which drives yields up and prices down. It tends to move into high-quality, liquid assets driving bond yields down and prices up.

 

As Warren Buffet once said:

‘Only when the tide goes out do you discover who’s been swimming naked.’

Fortunately, your portfolio has kept its trunks on!  

 

Use of Morningstar Direct© data

© Morningstar 2020. All rights reserved. The information contained herein: (1) is proprietary to Morningstar and/or its content providers; (2) may not be copied, adapted or distributed; and (3) is not warranted to be accurate, complete or timely. Neither Morningstar nor its content providers are responsible for any damages or losses arising from any use of this information, except where such damages or losses cannot be limited or excluded by law in your jurisdiction. Past financial performance is no guarantee of future results.

Data set

Data label Market index used
Global Govts 1-5 Hdg Markit iBoxx GBP Gilts TR
Gilts 1-5 TR FTSE WGBI 1-5 Yr Hdg GBP
GBP Corp 1-5 TR Markit iBoxx GBP Gilts 1-5 TR
Global Corp TR Hdg GBP Markit iBoxx GBP Corporates 1-5 TR
GBP Corp TR BBgBarc Global Aggregate Corporates TR Hdg GBP
GBP Corp BBB TR Markit iBoxx GBP Corporates TR
Global High Yield TR Hdg GBP Markit iBoxx GBP Corp BBB TR
Emerging Equity BBgBarc Global High Yield TR Hdg GBP
Developed Equity MSCI EM NR USD
UK Equity MSCI World NR USD

 

Risk warnings

This article is distributed for educational purposes only and must not be considered to be investment advice or an offer of any security for sale. The reference to any products is made only to make educational points and must, in no circumstances, be deemed to be any form of product recommendation.

 

This article contains the opinions of the authors but not necessarily Donald Wealth Management (the Firm) and does not represent a recommendation of any particular security, strategy or investment product. Information contained herein has been obtained from sources believed to be reliable, but is not guaranteed. 

 

It is not a promotion of Donald Wealth Management’s services. Donald Wealth Management strongly suggests that no investor should act on any of these ideas without first seeking financial advice.

 

Past performance is not indicative of future results and no representation is made that the stated results will be replicated. The value of an investment is not guaranteed and on encashment you may not get back the full amount invested. Errors and omissions excepted.

 

Donald Wealth Management is a trading style of Donald Asset Management Limited which is authorised and regulated by the Financial Conduct Authority in the United Kingdom (FRN: 223784). Donald Asset Management Limited is registered in England and Wales under Company No. 4675082. The registered office address of the Firm is: Stable End, 12 Heather Court Gardens, Four Oaks, West Midlands, B74 2ST.