2023-09-08 20:52:17
Bonds should once again play a more important role in a well-diversified portfolio. (Photo: 123RF)
The growth trend in financial assets over the past decade has been anchored in equity indices. At the same time, bonds appear to have lost their protective qualities and offer investors very little in the way of diversification.
This situation has come to a head in 2022. Last year, the bond market experienced one of the worst sell-offs in a generation, after central banks raised interest rates aggressively to contain inflation. Bonds and stocks fell in tandem, calling into question the merits of bonds in their entirety as a diversified asset class in a traditional 60% stock, 40% bond portfolio.
This is largely why, until recently, we had very little exposure to bonds in our multi-asset portfolios. However, the outlook for this asset class has changed. Today we see bonds as offering higher yields and better diversification in a multi-asset portfolio. We even went so far as to announce the “rebirth” of the 60/40 portfolio, while some still believe it is dead.
In this new reality, we see attractive opportunities to achieve decent returns in the bond market. The determining factors remain central bank policy and the degree to which interest rates will need to rise to bring down inflation. Given the pace of rate hikes to date, policymakers may well go too far, causing a slowdown in the economy and, in turn, a slowdown in consumer spending.
The gap with the real world
At the end of 2022, the forecast for 2023 revolved around one word: recession. It is said that it typically takes nine to 12 months for interest rate changes to be reflected in the real economy, but we believe it could last longer. In the UK and Canada, many homeowners have opted for five-year fixed rate mortgages and taken advantage of falling interest rates. It may therefore take longer for rising interest rates to be reflected in consumer spending.
It could be even longer in the United States, where 30-year fixed-rate mortgages are the dominant mortgage product, protecting the disposable income of people who took out these long-term loans. Additionally, older adults generally do not have mortgages and benefit from higher interest rates on their savings, increasing their overall purchasing power.
Furthermore, the combination of wages keeping pace with inflation and high levels of household savings has delayed the real effects of rising interest rates on the economy. However, monetary tightening should be felt by the end of the year.
Better diversification
When the economy finally turns around, we could find ourselves in a tough environment for stocks.
In this scenario, we believe government bonds should offer better diversification, especially given what they experienced in 2022. Therefore, Newton’s team has gradually increased its weighting in government bonds and, in a to a lesser extent, corporate bonds. We have also reduced our exposure to alternative products and reallocated resources up the capital structure in the bond market, given their attractiveness as income-producing investments.
Overall, we think bonds are worth investing in again, both for their return potential and for diversification purposes. In our opinion, they should once again play a more important role in a well-diversified portfolio.
(Photo: courtesy)
By Paul Flood, Head of Mixed Asset Investments at Newton Investment Management. Newton is a global investment management company owned by BNY Mellon.
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