The role of bonds in the portfolio of a client in decumulation

This article is part of
Guide to Bonds

The role of bonds in the portfolio of a client in decumulation

A strange feature of investment markets since the global financial crisis has been the precipitous rise in bond prices, with yields falling sharply, reducing the income available to clients in retirement, with equity yields being higher.

This has in effect reversed the typical asset allocation rule followed by many investors, with bonds owned for income and equities for capital growth.

Traditional asset allocation rules therefore place a client who is many years from retirement predominantly into equities, as a way to grow the size of the pot, and then move the client into bonds as they grow older and their risk appetite declines, and when retirement happens, the portfolio has a majority of the capital deployed into bonds to provide an income.

But in the decade since the financial crisis, bond yields have been driven constantly lower by a combination of central bank bond buying, and low rates of economic growth and inflation, making equities relatively unattractive.

The usurping of the recovery from the global financial crisis by the new uncertainties of the Covid 19 collapse has not changed the trend in bond markets, with yields plunging lower since March, and the interventions of global central banks have occurred at a pace far greater than happened even in 2008.

This has pushed government bond yields to new lows, with the UK 10-year gilt now offering an interest rate of 0.21 per cent, and the US 10-year Treasury bond has an income yield of 0.66 per cent. 

Both of those yields are considerably below the prevailing inflation rate, and so do not protect the client’s purchasing power in retirement. 

Alternative income products

Peter Doherty, head of fixed income at Sanlam says he favours having fewer government bonds and instead using alternative income products such as certain investment trusts, to generate the extra income.

He invests in these trusts as they are more liquid than buying the underlying investments directly. The investments are backed by assets.

Dean Cheeseman, multi-asset investor at Janus Henderson investors says: “In many ways the role of bonds in a decumulation portfolio has not changed, they are still there to act as a diversifier.

"The market in March showed that bonds still act as a diversifier, which is one of the reasons they are in a portfolio.

"But an argument can also be made that bonds are the most expensive they have ever been in history, and that is causing us to move into alternative income assets. The other thing we are doing is moving out of passive investment strategies and into active, as the performance of different types of bonds will diverge sharply, so now is not the time to be in passive funds. 

He adds that right now he prefers not to own strategic bond funds in the current climate.

Strategic bond funds can invest in any type of bond. Mr Cheeseman says right now he prefers to invest in bond funds that are focused on a particular part of the market, as this means he knows what they are invested in.