While we must accept bond prices are historically high and seem to offer an unappealing asymmetric payoff profile, it is not true that their diversification benefit has been lost. Correlations will fall to their lowest in times of stress, specifically the point when they are most required.
Retail investors do not display much flexibility in their capacity for loss. Despite having our cake and eating it under the beneficent protection of quantitative easing, we shouldn’t look to hold bonds over the longer term as a driver of our portfolio returns, even in the good times.
When determining an allocation to bonds, a thought to remember is that return diversification can be achieved through risky uncorrelated assets, but risk diversification is achieved through holding high-quality bonds.
Timothy Willis is an investment manager at Parmenion