InvestmentsApr 15 2021

Are bonds still relevant in a multi-asset approach?

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7IM
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Supported by
7IM
Are bonds still relevant in a multi-asset approach?
Pexels/Monica Silvestre

Creating a sustainable income in retirement is one of the most important pieces of financial planning people will do in their lifetimes.

Ensuring that they have enough to achieve ambitions, goals and security is paramount, and of course, there is no one set way to achieve this.

Using a multi-asset approach is a well-trodden path, but ensuring that market shifts and trends are accounted for is becoming a vital element of retirement portfolio planning.

One such area that is of increasing concern is the decline in yields from traditional income-bearing assets, namely in government bonds, prompting some to expand diversification frameworks beyond conventional approaches.

“Ultra-low yields leave investors in retirement with two choices,” explains Francois de Bruin, manager of the Aviva Investors Sustainable Income and Growth fund.

“One: accept lower returns and in most cases adjust lifestyle expectations, or two: take a fundamentally different approach to the asset allocation framework.”

Expense compounded over many decades is one of the biggest detriments to a long-term successful retirement strategy Jason Barefoot, Ascot Lloyd

Bruin explains that such a mindset is “derived from the capital asset pricing models” of risk and reward that many retirees have adhered to since the 1960s, yet a combination of current market factors, as well as societal shifts, is making such a framework hard to observe.

“With life expectancy and longevity on the rise, the problem posed by the trade-off between these two choices are as acute and important as ever,” he adds.

“The second choice involves a deeper understanding of the risks investors face on their retirement journey, as well as a willingness and ability to invest across a broader spectrum of asset classes.

“Furthermore, investors need to be highly selective, as aggregate markets today fail to offer the yields and returns they need to retire sustainably.”

The alternatives route

This is a sentiment echoed by Matthew Yeates, head of alternatives and quantitative strategy at 7IM. He says that it is becoming increasingly essential that multi-asset portfolios identify varying sources of return, and notably, ones that can maintain pace with inflation.

For Yeates, this means “larger allocations to areas such as alternatives, real estate and credit, including emerging market debt, instead of simply holding government bonds”.

However, increasing allocations to alternative assets is not a straightforward endeavour, as they are “inherently complex and expensive”, according to Jason Barefoot, chartered financial planner at Ascot Lloyd.

“Expense compounded over many decades is one of the biggest detriments to a long-term successful retirement strategy,” says Barefoot.

Low yields from government bonds leaves asset allocation space that needs to be filled to achieve the desired growth outcomes – but that does not necessarily mean that bonds and gilts are out of the picture entirely.

“Government bonds still have a place but likely to a lower extent than would have historically been so,” explains Yeates.

“With negative real yields on long-term government bonds, they are unlikely to deliver the sort of portfolio level returns many would expect or need to hit their goals.”

Bruin agrees that the role of government bonds is shifting.

“At the turn of the century, government bonds delivered yields between 4 per cent and 6 per cent, allowing investors to anchor their portfolio around the risk-free asset, and depending on their goals, allocate to growth in more volatile asset classes,” he says.

“With yields unable to drive returns higher, the primary attraction of government bonds is the flight-to-safety characteristic, which is still a feature even at low yields. US 10-year treasuries were yielding less than 2 per cent before Covid-19 and the asset class rallied more than 10 per cent when investors needed it most last year.”

Despite this, Bruin says that the odds are stacked against the asset class over the long term.

“Yields are closely correlated to prospective returns over longer-term holding periods of five years or more, so long-term investors should not expect a significant contribution to total returns,” he says.

“In fact, investors who participated in the US Treasury auction for 30-year bonds in August 2020 are currently holding bonds trading at less than 80 cents to the dollar as yields continue to move higher unabated.

“Government bond investors too need to proceed with caution.”

‘Peace of mind’

Barefoot adds that government bonds still deserve to be allocated within a retirement fund as a “volatility stabiliser”, and not purely on financial grounds, but to offer “peace of mind” to cautious investors. Security comes through as a potential source of funds to be “drawn in the event of a temporary market decline”, ideal for covering a "few years’ worth of expenses".

For Yeates, the issues surrounding government-issued bonds is reason enough to diversify from the traditional 60/40 bond allocation.

“We believe there is value in allocating to hybrid assets like emerging market debt, credit and real estate investment trusts, and believe splitting some of the equity out to balance risk here makes sense.

“So rather than a 60/40 portfolio, people should likely be talking more about a 40/40/20 portfolio,” he adds.

Yet regardless of market conditions, there is one universal truth in retirement planning: ensuring that the needs of the client are met.

“Retirement planning is merely a science of ensuring a client does not run out of money before they run out of life, while living their ideal lifestyle,” says Barefoot.

“How one does this is secondary, though the key aspects to consider are the exposure the client needs to have to the stock market to meet their plan; and the extent in which they structure withdrawals, and manage behaviour, during times of market suppression.”

Tom Higgins is a freelance journalist