Government Bonds  

Govt bonds no longer offer diversification ‘cushion’

Govt bonds no longer offer diversification ‘cushion’

The “cushion” provided by government bonds in market downturns is “just not really there anymore” as high prices and low yields leave little room for returns, an expert has warned.

Speaking on an FTAdviser webinar last week, Andrew Keegan, head of wealth portfolio solutions on multi-asset strategies at BlackRock, said government bonds provided a “real challenge for lower risk investors” as they offered “risk but very little reward”.

He said: “Low interest rates are nothing new, but the dramatic drop in the yield of government bonds raises big questions.

“The cushion that government bonds provided in scenarios is just not really there anymore. If we look out over the next few years, we’re in a world which is very uncertain...and the typical reliance on bonds will not be there.”

Typically, the price of government bonds will increase — and the yields decrease — in times of market downturn as investors flock from falling equities towards traditional ‘safe haven’ assets such as government bonds.

This means that those investors who already hold government bonds at such a time would see the price of their asset increase, and therefore holding government bonds diversifies against stock market crashes.

But government bond yields have hit historic lows this year. In July, British 10-year government bond yields sank to their lowest on record to 0.07 per cent and today’s yield of 0.34 per cent is little better.

This means there is limited room for bond yields to fall — and prices to rise — heading into another market crash, and therefore the “cushion” typically provided by such bonds is not as protective.

The same was true in March when global markets tumbled in anticipation of the coronavirus crisis. As yields were already at historic lows, 0.16 per cent on March 9, there was a short supply of profit for low risk investors to make from their government bonds.

Also speaking on the webinar, Adrian Lowcock, head of personal investing at Willis Owen, said it was a case of being diversified within bond markets themselves.

He said: “I still think bonds are an appropriate diversifier, but it’s a case of being diversified within bond markets.

“There’s currency, duration, high yield, quality bonds. I still think there is a place for it, but it’s about getting that allocation right.

“Investment grade bonds can be used as a replacement for government bonds in some circumstances — there are some excellent quality companies that are in that market who are not anywhere near as indebted as some governments out there.”

Mr Keegan agreed, urging investors to be more “nimble and selective” about their fixed income options.

Due to the economic uncertainty caused by the coronavirus crisis, it was important advisers reviewed their clients’ investment goals, strategies and suitability alignments, the panelists said.

Mr Keegan said: “You have to keep an eye on the types of risks in your portfolio, and even if it might have been suitable in the past, whether it will be the same for today and tomorrow.”