The traditional 60/40 investment portfolio solution faces a major challenge as nearly £3bn has been wiped off the value of UK corporate bonds since the start of 2022.
Research from digital asset manager Collidr found in the first six months of this year that total outstanding UK corporate bonds fell 13.3% from £2.2bn to £1 £.9 billion, the biggest percentage drop in the UK corporate bond market. Since 1998.
Over the same period, the FTSE 100 fell 3%.
Collidr research also showed that £283.8bn had been wiped off the value of gilts (UK government bonds) since the start of the year, representing a 14.8% drop – the steepest decline since the 1980s.
Bond prices have been affected by rising interest rates and inflation since the start of the year, in response to central banks tightening monetary policy to control inflation.
Collidr said the crash in bond prices has been a major challenge for those who hold bonds defensively, assuming they will provide downside protection when stocks fall.
In particular, the firm’s chief investment officer, Colin Legget, said the collapse in bond prices threatens the concept of the traditional, static 60/40 portfolio solution.
Assuming that a 40% weighting in bonds will reduce overall portfolio risk and volatility, the 60/40 strategy is used by many fund managers for retail investors.
But Legget explained that because bond prices have become so stretched, they are now vulnerable to rising inflation and interest rates.
Collidr said the bond sell-off is the latest evidence that the 60/40 concept does not provide investors with sufficient protection against downside volatility and that investors should seek alternative asset classes to bonds if they want real diversification.
“For investors looking to offset equity volatility, corporate bonds aren’t the answer right now,” Legget said.
“The sell-off in the bond markets poses big problems for fund managers. Few individual fund managers have actually weathered a bond market decline of this magnitude.
“Many of them have to stick with a strategy that no longer works or have to go through a steep learning curve to invest in alternative asset classes that they are unfamiliar with.”
However, other players in the sector said it was worth considering building a position in the bond market, given that a recession is looming in the not-too-distant future.
For investors looking to further diversify, Collidr said strategies such as long/short equities, market neutral funds, currency trading, and assets such as commodities, oil, and real assets such as than real estate are worth considering.
He also said that investors should consider investing in quality large-cap companies that have brands that customers cannot live without, as these are the types of companies that have the power to set prices for help offset the impact of inflation and should perform better as rates rise.