Should investors buy bonds as a buffer?

Should investors buy bonds as a buffer?

Should advisers be pushing government bonds as a buffer against an equity market correction?

Richard Turnill, BlackRock’s global chief investment strategist, said he advocates a strategic allocation to government bonds, despite their low potential return, despite the fact the investment house favours stocks overall.

He said: “We advocate strategic allocations to government bonds including Treasury inflation-protected securities (Tips) for diversification purposes – even in the case where bonds underperform cash.

"We do not advocate large cash allocations, as cash dampens but does not diversify equity risk."

Stocks and bonds are usually negatively correlated, meaning that when one moves up the other moves down.

However, at some points in recent years, this negative correlation has not held true, and share and bond prices have moved together, for example during the 2015 spike in German bond yields. 

Mr Turnill said that as a result of this “some investors have lost faith” in the principle of negative correlation.

However, he pointed to the performance of bonds and shares early last week, when North Korea-related geopolitical concerns escalated and equities fell as bonds rose.

He described this as “a timely reminder to diversify equity risk via an allocation to government bonds, in our view”.

Tom Stevenson, investment director at Fidelity, agreed that it makes sense to think about how to protect a portfolio, with the equity bull market well into its ninth year.

He said: “Growing geo-political risks can only increase investors’ nervousness.

“Government bonds are traditionally uncorrelated with equities, although in recent years monetary policy has tended to push both bonds and shares in the same direction.  

"If there is an equity market setback, however, it is reasonable to think that the old relationship might reassert itself.

"That is because central banks are acutely aware of what is going on in the markets. Stock market weakness would most likely lead to a reversal of the recent tentative tightening from the Federal Reserve.

"It would certainly persuade the European Central Bank (ECB) and Bank of England to put off interest rate normalisation in Europe and the UK.

“Alongside a slightly bigger cash cushion, bonds could help soften the blow of an equity market correction.”

However, some financial advisers warned that the bonds might not be providing as much stability as they might, because they have become expensive.

Patrick Connolly, head of communications at Chase de Vere, said: “Traditionally government bonds provide the best protection to stock market falls and so should merit a role in investment portfolios for those who want some degree of capital protection.

“However, there is a concern that these bonds are expensive and so rather than providing stability they could potentially be subject to significant falls.

"The best approach is to be selective in terms of the bonds used and their weightings and this can be done by using strategic bond funds managed by good quality investment teams.”