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There is a perception that bonds are for “cautious” investors and that equities are for more “aggressive” investors, and that’s partly true. Yet 2020 has cast a spotlight on bonds in light of COVID-19 and other events in the economy (e.g. Governments around the world buying bonds). In this article, our financial planning team at WMM in Oxford wanted to share this round-up of the key developments and trends regarding bonds within the last 12 months. We hope you find this helpful and invite you to get in touch if you have any questions.
Bonds: overview & 2020 highlights
To briefly recap: a bond is a type of “IOU” between you (the investor) and a borrower such as a government or company. The latter issues a bond which you can then “buy” in the hope that it will eventually be repaid – with interest along the way. This is why bonds are classed as “fixed income assets”, since they do not only provide a return when they are sold (like equities).
What’s helpful about government bonds is that they are often negatively correlated with equities. So, when the stock market goes down (as it did earlier in 2020), bonds are often widely seen as a “safe haven” by investors. This makes bonds a useful diversifier in a portfolio, since they allow for a degree of capital preservation should developed economies enter a bear run. Since bonds are typically less volatile than equities, they are usually seen as less “risky” and so do not tend to provide the same returns as the latter (although the longer the duration of a bond – e.g. 10+ years – the “riskier” it is and thus the “higher return potential” it is likely to be).
In 2020, however, the curious thing that’s happened is that the Bank of England (BoE) has lowered the base rate to its lowest point in history – i.e. 0.10%. This means that it is “cheaper” for the UK government to borrow money from investors. Bonds, moreover, experience a rise in market value when rates fall. Since coupon rates are higher, more people want to buy bonds – leading to a rise in demand which pushes the price higher. As such, current bondholders might be able to sell their existing bonds for a higher price than their face value.
What’s difficult to establish in the present climate, however, is what’s going to happen to interest rates in the near future. After all, the BoE base rate cannot go much lower than 0.10% – which suggests that, at some point, interest rates might rise. In which case, the market value of bonds would fall. Unfortunately, nobody knows if/when this might happen.
Remember that governments and companies can issue bonds? The COVID-19 pandemic has certainly had an impact on both – but especially the latter. After all, if companies come under considerable financial strain (e.g. due to lower consumer demand during a lockdown) then they are less likely to service bond payments. Fortunately, institutions such as the Federal Reserve can have a big influence on bond markets. Indeed, the aforementioned stepped in in 2020 to normalise spreads and get credit flowing – avoiding a “doomsday scenario” in the US economy.
The big question, of course, is what will happen in the months ahead – especially as the world continues to navigate its way through the coronavirus crisis? Whilst nobody can say for certain, it does appear that the most severe part of the current recession has already happened (i.e. in the first and second quarters of 2020). If this turns out to be the case, then core bond yields look more promising going forwards (since they would have already hit their “bottom”).
Interested in finding out how our bond strategy is used in conjunction with global equity exposure, to optimise your own financial plan? Get in touch today to arrange a free, no-commitment consultation with a member of our team here at WMM.
You can call us on 01869 331469