The traditional 60/40 investment portfolio solution is facing a major challenge, as almost £300bn has been wiped off the value of UK corporate bonds since the start of 2022.
Research by digital asset manager Collidr revealed in the first six months of this year, the total outstanding value of UK corporate bonds has fallen by 13.3 per cent from £2.2tn to £1.9tn, representing the biggest percentage fall in the UK corporate bonds market since 1998.
Over the same period, the FTSE 100 fell by 3 per cent.
Collidr’s research also showed that £283.8bn has been wiped off the value of gilts (UK government bonds) since the start of the year, representing a 14.8 per cent fall - the biggest drop since the 1980s.
Bond prices have been hit by rising interest rates and inflation since the start of the year, in response to central banks tightening monetary policy to control inflation.
Collidr said the collapse in bond prices has been a major challenge for those who hold bonds for defensive purposes, on the assumption they will provide downside protection when equities are falling.
In particular, the firm’s investment director, Colin Legget said the collapse in bond prices threatens the concept of the traditional, static 60/40 portfolio solution.
Based on the principle that a 40 per cent weighting in bonds will reduce the risks and volatility of the overall portfolio, the 60/40 strategy is used by many fund managers for retail investors.
But Legget explained that because bond prices have become so overstretched they are now vulnerable to rising inflation and interest rates.
Collidr said the sell-off in bonds is the latest evidence that the 60/40 concept does not offer investors sufficient protection against downside volatility and that investors need to look at alternative asset classes to bonds if they want true diversification.
“For investors looking to offset the volatility of equities, corporate bonds are not the answer at the moment,” Legget said.
“The sell-off in the bond markets is causing big challenges to fund managers. Few individual fund managers have actually worked through a fall in the bond markets of this scale.
“Many of them are either having to stick with a strategy that isn’t working anymore or are having to go through a steep learning curve to invest in alternative asset classes that they are unfamiliar with.”
However, others in the industry said building a position now in the bond market is worth considering given that a recession is looming in the not so distant future.
For investors looking to diversify further, Collidr said strategies such as long/short equity, market neutral funds, currency trading and assets like commodities, oil and real assets such as property are worth considering.
It also said that investors should explore investing in large cap quality companies that have brands that customers cannot live without as these are the kinds of businesses that have the pricing power to help offset the impact of inflation and should perform better as rates rise.