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Bonds and the benefits of a diversified portfolio

29 April 2020

5 minute read

While the coronavirus pandemic has seen global share markets collapse around the world, government bond prices have rallied. Here, we explore the reasons why bonds have been trading higher and what this means for a diversified investor.

Who's it for? All investors

The value of investments can fall as well as rise. You may get back less than you invest.

What you’ll learn:

  • The impact of the coronavirus on markets and the economy
  • Why bonds have benefited from the recent market turmoil
  • How bonds can help deliver diversification benefits

The recent collapse in global share markets has sent shockwaves through the world and, for many investors, meant heavy falls in the value of their investments. But it’s not all bad news. While share prices have slumped, government bond prices have rallied. Here, we explore the reasons why bonds have been trading higher and what this means for a diversified investor.

When we talk about government bonds, we are talking about debt instruments issued by governments to finance government spending as an alternative to taxation. In the US, these bonds are known as Treasuries and, in the UK, Gilts.

Why have bonds been rising?

As the coronavirus has taken hold, supply chains have become disrupted, productivity has slowed and companies have struggled to stay afloat. Widespread uncertainty about the severity and duration of this outbreak has seen investor sentiment plummet.

Economies are slowing down and there is a very real possibility of a global recession. Central banks and governments around the world have taken affirmative action to support markets and the economy through massive stimulus measures and emergency interest rate cuts.

In the past, lowering interest rates has caused inflation expectations to rise. This is because lower interest rates tend to have a net benefit to the economy and suggest a brighter future ahead. However, stubbornly low inflation has meant that the inflation rate has undershot the target rate for some time, and appears reluctant to pick up any time soon.

What does this mean for investors? Well, with no inflation concerns on the horizon – and interest rates at, or close to, rock bottom – investors are willing to pay ever higher prices for bonds. This is because bond prices move inversely to yields so, as bonds prices rise, yields (or the return on a bond) fall.

Safe haven?

Central banks, including the US Federal Reserve and the European Central Bank, are currently reviewing the yardsticks of success for policy setting. This has typically been the annual rate of inflation, but now some officials have suggested looking at the longer term average rather than just an annual average. Essentially, this would allow central banks to tolerate higher inflation after a period of low(er) inflation. This should help in keeping investors’ expectations that inflation will pick up at some point in the future, which will make bonds less attractive.

Meanwhile, most central banks in the West have set interest rates at close to zero. This has meant that having bonds as a safe haven in portfolios is plausibly becoming less powerful. Why? Because, realistically, central banks cannot lower interest rates any further. However, it is worth pointing out that investors who continue to hold the bonds to maturity will receive their initial investment back (plus the yield on offer), as the risk of default from developed government bonds remains very low (although not impossible). Instead of lowering interest rates further, governments will need to support their economies through other methods – such as fiscal measures – which stabilise the economy by adjusting the levels and allocations of taxes and government expenditures.

Diversification

In order to mitigate the risk of loss, it is best not to rely on a single investment. Bonds help to manage risk by offering diversification benefits in a multi-asset portfolio. The Barclays Ready-made Investments are just one example of a range of diversified funds which allow you to select the level of risk you are most comfortable with. These multi-asset funds invest across a range of asset classes and regions, offering a globally diversified one-stop solution for investors. Ready-made Investments are not the only funds that we offer and they won’t be appropriate for everyone.

Smart Investor offers a wide range of funds, and our Barclays Funds List may help you to narrow down the wide range available to invest in. These funds are selected by Barclays investment specialists and, based on our research, they’re the funds that we believe have the potential to generate consistent returns over the medium to long term.

Funds are designed for the long term so you should only consider them if you can stay invested for at least five years.

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The value of investments can fall as well as rise. You may get back less than you invest. Tax rules can change and their effects on you will depend on your individual circumstances. Smart Investor doesn’t offer personal financial advice. If you’re not sure about investing, seek independent advice.

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