What role can different bond types play in a portfolio?

So how do managers find high-quality bonds that offer enough of a cushion against risk but still achieve a decent spread? 

What of the 60:40 rule?

The traditional way for investors to accumulate money within a balanced portfolio has been to have 60 per cent in equities and 40 per cent in bonds.

Over time, as the individual's lifestyle changes – perhaps the investor has retired and wants a higher income payout and a lower exposure to equity market risk – the equity weighting would typically reduce while the bond allocation rises. 

But the recent bond sell off has challenged the concept of a 60:40 portfolio.

In the first six months of this year, the total outstanding value of UK corporate bonds fell by 13.3 per cent to £1.94trn from £2.24trn, a fall of £297.5bn.

This compares with a fall of 3 per cent for the FTSE100 over the same period, while gilts dropped by 14.8 per cent, the biggest drop since the 1980s.

Collidr's investment director Colin Leggett says the collapse in bond prices has been a major challenge for those who hold bonds for defensive purposes, on the assumption that they will provide downside protection when equities are falling.

According to Leggett, this collapse in bond prices has put “another nail in the coffin” to the traditional, static 60/40 portfolio solution that many fund managers have developed for retail investors.

He says: "The 60:40 strategy is based on the principle that the 40 per cent weighting in bonds will reduce the risks and volatility of the overall portfolio.

"However, bond prices have become so overstretched they have been vulnerable to rising inflation and interest rates."

Not dead yet

But Quilter Cheviot's investment manager David Henry says people should "not be so fast" to say the 60:40 model is dead.

He says: "I have certainly had more emails recently from fund houses landing in my inbox decrying the death of the classic 60:40 equity/bond portfolio than I have in previous years.

"But if we look at the historical numbers, maybe the grim reaper should hold onto his horses."

He explored quarterly returns for stocks (MSCI World, the global stock market) and bonds (gilts, loans to the UK government) since 1986. 

There were nine quarters when the prices of both bonds and stocks fell in tandem. It has only happened once since 1986 in consecutive quarters – Q1 and Q2 2022.

"Breakdowns in diversification, like we have seen this year, are rare. We then looked at 12-month forward returns for a 60/40 asset allocation following quarters where stocks and bonds fell together." 

Overall, he says – citing the table below – returns were pretty healthy following those quarters.

Source: Quilter Cheviot

For Gavin Haynes, investment consultant and founder of Fairview Investing, a "barbell approach" might make sense.