Given the market turmoil over the last 6-12 months, succession planners have asked us a lot of questions on fixed income markets. Sunil Krishnan, head of multi-asset funds at Aviva investors, answers your questions on the role of bonds in clients’ portfolios.

Q: Everyone understands equities’ place in a portfolio and how they deliver returns over the long term. But given what’s happened in the past year, is there still a role for bonds? Put another way, why would anyone buy a 20 per cent equity / 80 per cent bond fund when they could just hold equities and cash?

Sunil Krishnan (SK): Bonds do have a role to play, but we need to revisit what that role is. Bonds should offer a yield or income and also some protection, when equities face sharp falls, to help dampen portfolio risk.

The challenge is we had been spoiled for the last 20 years in two ways.

Firstly, bonds almost always offered protection when markets got even a little difficult, because central banks usually came to the rescue, driving yields down. Secondly, bonds offered large and sustained capital appreciation as yields continued to fall (bond prices go up when yields fall and vice-versa), but that is not their main role in a portfolio.

Today, things have changed. We shouldn’t expect bonds to continue delivering persistent capital appreciation because we can’t assume yields will go steadily down from here. Moreover, we can no longer expect bonds to always offer protection when equities dip because central banks won’t always rescue markets, as we are seeing now.

However, in a recession, when equities are doing badly because earnings are weak, bonds are often the only game in town – especially government bonds. This is because, when recession hits, central banks are generally forced to cut rates to help reduce the pressure on households (who will generally have mortgage repayments, car loans and other possible debts). This pushes up bond values.

But perhaps the most important point is that the yield for bonds is the most attractive it has been in years. Many people haven’t noticed because of rising cash rates, but yields on government bonds are currently around four per cent and yields on corporate credit are around 5.5 per cent. That means the bond portion of an 80/20 portfolio is generating an attractive income.

Q: Annuity rates are very attractive right now. Does that make multi-asset less attractive?

SK: Annuity rates have improved because the yields on the bonds that underpin annuities are higher, and higher bond yields also mean better returns in multi-asset portfolios. Moreover, multi-asset offers flexibility in retirement and may leave a pot for the next generation. While an annuity gives certainty, it is less flexible and won’t leave an inheritance value. Those reasons continue to make multi-asset portfolios attractive.

Q: Is the traditional 60/40 dead and is there something better than bonds to diversify a portfolio?

SK: As you said, the 60 per cent of equities takes care of itself. Meanwhile, the 40 per cent of bonds is arguably in a better place than it has been for years because yields are more attractive. That said, we can no longer rely on bonds to be negatively correlated to equities and protect portfolios from all periods of volatility.

We can no longer rely on bonds to be negatively correlated to equities and protect portfolios from all periods of volatility

In terms of better alternatives, it isn’t straightforward because investing in alternatives simply swaps one type of risk for another, like illiquidity instead of volatility. It is not easy to find alternative assets that consistently offer uncorrelated returns at a reasonable cost. That said, last year, some liquid alternatives worked well.

Q: Should I just stick with equities if I have the appetite for risk?

SK: In short, yes, equities make sense. Overall, they are cheap and liquid, they capture innovation and human ingenuity and are the right way to build wealth over the long term. That said, we know investors can often get nervous at the start or end of the journey, so it makes sense to also have lower-risk options.

Q: How long does an investor need to invest for and does timing matter?

SK: I think you should stay invested a minimum of seven years for the odds to be sufficiently stacked in your favour. But we have seen episodes in the past where you could be unfortunate with the timing, and it could take longer than seven years for a portfolio to recover.

Interestingly, the point at which you invest in the market cycle is an important factor in determining how long it might take to see positive returns. If valuations are high when you invest, you could be unlucky, whereas if they are at a low point, it generally shouldn’t take as long to see positive returns. 

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