The role of bonds in a multi-asset portfolio

This article is part of
What is next for the 60/40 multi-asset portfolio?

"There is massive diversity across three dimensions: from short duration to long duration, good-quality credit to poor quality and, not to forget, liquid and less liquid.” 

Short-duration bonds are those that will mature relatively soon, and so carry less interest-rate risk, relative to those that have a longer date. 

Rayner says this is how one should allocate to bonds at the moment – by investing in shorter-dated bonds with higher yields, one can still attain an income and garner some element of protection from higher yields. 

One option for investors seeking a higher income from the bond slug of a multi-asset portfolio is to replace government bonds with riskier corporate bonds, including those with a high-yield credit rating.  

Bonds are given a credit rating based on the letters of the alphabet and numbers. Most developed-market, government bonds have a credit rating of AAA, while high-yield bonds are those with a credit rating of below BBB. 

Julian Howard, investment director for multi-asset solutions at GAM, says this is the wrong way to approach a bond allocation.

He says that while government-bond yields are so low as to not presently offer much protection against inflation, rather than taking on extra risk with the bond part of the portfolio, one should stick with the lower-risk bonds to act as a defensive asset class and use the equity and alternatives to combat inflation.

Charles Hovenden, portfolio manager at Square Mile, says one of the problems with allocating to riskier bonds in the current climate is that the extra income yield one gets for taking the extra risk (known as the spread) is currently very low, and not worth taking.

He adds that clients considering allocating to the highest-risk bonds should bear in mind that instruments that are called high yield in the UK are known as “junk” in the US. 

John Stopford, head of multi-asset income at Ninety One, is also reluctant to invest in bonds further down the market-cap scale.

He says: “‘Reaching for yield’ is not the answer if the question is, 'What defensive asset should I be buying instead of government bonds?'

"Moving down the credit-risk spectrum into high yield is fraught with greater risk, given the increased chance of capital losses and the lack of diversification to equities.

"We believe the use of equity-index futures and options to reduce risk provide a better alternative for diversifying against equity risk than government bonds currently.”