The role bonds play in your investment strategy

For over a decade now, bonds have more than justified their part in a well-diversified investment strategy, delivering steady income streams in a low-interest-rate environment as well as protection during times of market volatility. 

However, as the global economy emerges from the COVID-19 pandemic, disruptions to supply chains and product shortages has seen the rate of inflation in some developed nations hit their highest level in more than a decade.

In turn, this pickup in inflation, coupled with a rebound in global growth, has seen a steady rise in government bond yields over the past 12 months – a scenario where bonds tend to underperform other asset classes. Furthermore, in times of above-average inflation, the value of the fixed income streams offered by bonds is eroded as inflation outpaces the income streams. For example, you may be receiving a 2% yield on a bond, but the price of everyday goods and services (inflation) goes up 3%.

Given the above, you may be wondering whether or not bonds are still justified in an investment strategy.

However, no matter the investing environment, bonds play an integral part in a diversified portfolio – let’s take a look at bonds generally, and ANZ Investments’ international bond investment approach. 

Bonds are considered a defensive asset because they are less volatile than other asset classes such as equities, and provide one of the most important features of an investment portfolio – diversification.

Over time, equity markets experience numerous periods of uncertainty and volatility. Think back to the 2008/2009 Global Financial Crisis when some equity markets fell around 50%. Or more recently, the sell-off in early 2020 as the COVID-19 pandemic unfolded. During these periods, the price of bonds rose as investors sought out high-quality safe investments, which helped smooth out the bumps of the broader portfolio performance.

Secondly, most bonds offer income generation in the form of a steady stream of cash flow, known as coupon payments, which can help mitigate any uncertainty. Bondholders can use the income generated for spending, or for reinvestment. And while equities can offer income generation through dividends, these payments can be less certain and tend to decline as equity markets fall and economies slow down.

Bonds also offer investors capital preservation. Unlike equities, unless the issuer defaults, the full principal value of a bond is returned to the investor at maturity, which can make bonds appealing to risk-averse investors who may be concerned about losing some of their initial capital.

At ANZ Investments, we take a multi-manager approach to our international bond investing through our diversified funds, which is why we invest in three underlying funds managed by two active managers – PIMCO and Northern Trust Asset Management.

The strategy invests in a mixture of government and corporate bonds, as well as asset and mortgage-backed securities, with a strong emphasis on quality. In addition, we only invest in investment-grade bonds, avoiding high-yield or “junk” bonds.

Our International Sovereign Fund adopts a GDP-weighted approach. This means that compared to a market capitalisation-based approach, we reduce our exposure to countries that have high debt-to-GDP ratios that could struggle to service debt during more challenging markets conditions.

For corporate bonds, the Northern Trust strategy selects securities based on valuation, quality and ESG (Environmental, Social, and Governance) considerations. 

The third strategy, managed by PIMCO, can invest across the full range of global bonds including government, semi-government, corporate bonds, as well as asset and mortgage-backed securities. Their large team of investment specialists looks to add value by positioning their portfolio in terms of duration, selecting which bonds they expect to outperform (sovereigns vs. credits vs. securitised) and selecting individual issuers.

At home, the responsibility for the investment strategy and the underlying managers lies with Alan Clarke, Maaike van Tol, and the Investment Strategy team. They appoint the fund managers and review them on an ongoing basis. Additionally, they are responsible for allocations between the three underlying strategies, all part of our active management approach.

In terms of our positioning, we are underweight fixed interest both international and domestic, believing the outlook for growth remains positive, which should see interest rates continue to rise – leading to an underperformance in bonds, relative to other asset classes.

So while the outlook for bonds may seem challenging right now, our team of investment specialists has the tools to position our funds during the ups and downs of investing.