Bonds in 2020 – how have they been affected?
This content is for information purposes only and should not be taken as financial advice. Every effort has been made to ensure the information is correct and up-to-date at the time of writing. For personalised and regulated advice regarding your situation, please consult an independent financial adviser here at Castlegate in Grantham, Lincoln or other local offices.
Wouldn’t it be interesting if there was an investment asset which has a negative correlation with stocks (equity), which tends to rally when stock markets crash and which is easy to buy or sell (i.e. highly “liquid”)? What if central banks across the world were also keen to buy them? There is, in fact, such an asset – government bonds in developed markets.
The key questions, of course, are: what are the implications of holding these types of bonds in an investment portfolio, and how have they been affected by the coronavirus pandemic? Here at Castlegate, our Grantham-based financial advisers offer this short guide to assist. We hope you find this content helpful, and invite you to get in touch if you’d like to discuss your own financial plan with us. You can arrange a free, no-obligation financial consultation at our expense:
Why hold bonds?
Different investors may find various types of bonds more suitable for their portfolio depending on their unique financial goals, situation and attitude to investment risk. However, perhaps the most prominent reason for holding government bonds (in developed countries) is to help preserve your capital. Quite simply, when stock markets crash – as they did in the first quarter of 2020 in the wake of coronavirus – government bonds tend to rally. Government bonds are also a liquid, reliable hedge for equity volatility. They can also provide a small income.
Regarding risk and return, with bonds the latter needs to be traded off against the former. The key concept to grasp here is duration. When you buy a short-term UK government bond, you are locking in a fixed rate of interest for a short period of time. With a long-term bond, you are doing the same but over a longer timeframe (e.g. 30 years). The latter is riskier than the former, since there is more time for interest rates to go up.
Bonds in 2020
If you look at what happened in 2008-9 to bonds during the global financial crisis, the equity market sold off gradually and then quickly – falling eventually by about 50%. However, short-term government bonds barely moved and largely preserved the value of capital. Longer-term US Treasury bonds (e.g. 7-10 years), however, rallied more when the equity sell-off truly hit, thus providing a strong hedge. A similar pattern amongst government bonds can be seen from early 2020, where they performed well in the wake of big equity sell-offs due to the pandemic and subsequent global lockdown.
Of course, at the time of writing global equities have not continued their downward plunge from earlier in the year. What might this mean for the bond market and should it affect how investors include them within their investment strategy? Here, it’s important to remember a good rule of thumb – bonds can provide a strong diversifier from equities, and it can be helpful to include those of the former which “zig” when the latter “zag”. In short, if you can find bonds which tend to rise in value when stocks fall, then this can help to shield your portfolio from excessive harm (e.g. during a bear market – perhaps one caused by a large “second wave” of COVID-19).
Examples of bonds which might achieve this at the present time could be, for instance, 7-10 year US Treasury bonds, which have, historically, had quite a large negative correlation with the S&P 500. These provided a strong hedge during the 2008-9 financial crisis, and the evidence so far suggests that they have generally also been a good diversifier in 2020 during the market volatility caused by the pandemic.
So, what is the outlook for bonds looking ahead in the rest of 2020 and beyond? As we always say here at Castlegate, no financial adviser can predict the future. We can only describe some of the main current conditions and trends which may affect yields in the coming months and years. One of the crucial aspects of the economy to watch will be inflation. So far in 2020, many governments have been busy printing money as central banks have provided extraordinary stimulus to help ease financial stresses caused by COVID-19.
If inflation rises far beyond the target 2% provided by the Bank of England, then this will eat into the yields offered by fixed-term investments such as government bonds. At present, it is unclear whether the events we have witnessed so far in 2020 will lead to a period of inflation or deflation. For those concerned about inflation, you might consider speaking with your financial adviser about the suitability of inflation-linked government bonds for your portfolio. These can help to protect the value of your principal and coupon against rising living costs. Yet they also carry certain risks, since their value tends to fluctuate with interest rates (which can rise or fall over time).
Conclusion & invitation
If you are interested in discussing your own financial plan or investment strategy with us, please get in touch to arrange a no-commitment financial consultation at our expense: