Never Say Never Again: Bonds Are Back?

It was well timed. To use a superhero metaphor, inflation is “kryptonite” for bonds – it reduces the purchasing power of the earned interest. This is why 2022’s spike in inflation drove bond prices lower. Equally, when inflation fades bond prices tend to rally and that’s happened since my 2022 column.

Could this signal that the bonds are back in town, as is their place in an investor’s balanced portfolio? With income yields far higher than they were during the years of low interest rates ahead of 2022, bonds may offer an effective way of income investing again. They also have the potential to cushion a balanced portfolio of equities against rocky markets.

In the UK and Italy, 10-year government bonds once again pay a significant positive yield accounted for inflation (known as a “real yield”, see chart). In other markets like France and Germany, government bond yields have also inched into the positive territory.

Source: Bloomberg.

Potential Price Rises and Attractive Yields

After this price recovery what happens now? If inflation falls further—as is hoped for in Europe, the UK and US—then bond prices should rally even further than they already have.

Balanced Portfolios for Everyone

More fundamentally, though, bonds normally have an effective role to play as stabilisers in investment portfolios. [Our range of multi-asset ETFs are a one-stop-shop for every aspiring multi-asset investor at a cost of just a few dozen basis points.]

One can build such a balanced portfolio yourself using ETFs, tailored to risk preferences by increasing or decreasing the relative weightings of shares and bonds. Low correlation between equities and bonds could also be an ally in a quest to diversify the returns, however one should not forget that it tends to spike during times of economic uncertainty.

Source: Morningstar. Data in USD, Net Return. Global Equities represented by the MSCI World index, Global Bonds by the Bloomberg Global Aggregate index. Past performance is not an indicator of future returns. You cannot invest in an index.

For a while the 2022 bond market correction shook faith in the traditional portfolio allocation theory that recommends a balanced equity-bond portfolio for certain investor types. Yet as real yields move back into positive territory, so confidence is returning.

Currently, the bond yields could be considered attractive and would be even more so if inflation and interest rates fall further. This could prompt another look by a wise investor looking to enhance their core portfolio.