Economic Outlook: Bonds behaving badly

03 May 2022 Expert insight

This content has been supplied by a commercial partner.

Bonds are a cornerstone of a charity portfolio due to their ability to pay an income while protecting your portfolio when needed the most. Considering the volatility of the past two years, one would expect that bonds would have performed very well.

Wrong. Over the past two years they are down – a lot. The bedrock of the balanced portfolio has delivered a real return of -20% over the past two years, according to Bloomberg. Our calculations suggest that’s the worst inflation-adjusted performance since 1981.

Traditional charity balanced portfolios rely on equities and bonds – equities for good times, bonds to cushion the bad. But after a torrid three months for markets, investors are being forced to tear up the rulebook.

One rule is that bonds diversify and protect portfolios. For the past three months, bonds have done anything but protect.

Unsurprisingly, investors are beginning to turn to “alternatives” instead of bonds – often in the form of private equity, property and infrastructure.

In recent years such “alternative” assets have delivered consistent, inflation-protected cash flows. However, that was when inflation was low and predictable. Will they really continue to deliver when inflation is high and threatening a cost-of-living crisis? Will governments allow infrastructure and similar projects to raise prices by up to 10% or more?

A new regime

We believe we are at the beginning of a new investment regime. Therefore, we look to inflation-linked bonds as a key defence in a world of deepening negative real yields – where inflation consistently exceeds interest rates. Critically we also look to options, which benefit from rising interest rates, to offset the duration risk of the index-linked bonds.

Exposure to gold and other commodities could also be part of a diversified solution. Meanwhile, we all need to rediscover the art of stockpicking, balancing bravery and caution to own equities which can capture opportunities in an increasingly volatile environment. The result is a portfolio that works differently and can act as an alternative to alternatives.

Most of all though, and in light of recent events, it’s necessary to be humble in the face of uncertainty. Build a portfolio first to survive, and second to thrive.

Jasmine Yeo is an investment manager at Ruffer 

Ruffer LLP is a limited liability partnership, registered in England with registered number OC305288 authorised and regulated by the Financial Conduct Authority. The information contained in this article does not constitute investment advice or research and should not be used as the basis of any investment decision.


More on