REGULARS | INVESTMENT COMMENTARY
A bond is broken Gone are the days of the boringly dependable bond, writes David van Schaardenburg. BY DAVID VAN SCHAARDENBURG
W
hen Ian Fleming was thinking of a name for the central character of his thriller spy novels amongst the range of theories was that he sought a name which would be deadly dull and unremembered. Hence the surname “Bond”. As a member of the famed merchant banking family, most notable for his grandfather founding Robert Fleming and Co, Ian Fleming most likely had a view that bonds were dependable and boring delivering a steady return to investors with little risk.
History can be an illusion If one looks at bond index performances for most of the last 35 years, Fleming was right. Since the high inflation era of the 1970s and 1980s successful central bank monetary policy has driven down inflation, bond yields and ultimately interest rates. Over these decades bond investors have enjoyed both relatively high (to today) bond coupon payments and with relentlessly declining yields, 26 | ASSET 02 | 2021
capital gains. The last part of this decline to new record low interest was driven by the unexpected event of a global pandemic. Bonds have been boring yet great performers for the last 35 years. A la James? However, in the latter part of Q3 2020, with US 10-year Treasury yields reaching 0.5% and NZ government bond yields similar, doubt was growing in my mind that bonds would in future perform the same valued role they had performed for decades. This is especially apparent for conservative and balanced portfolios where bonds made up more than 50% of the investments. I’ll take a stronger view. There has been for the last year no logical reason to hold bonds in the portfolio of any investor. For investors with short-term horizons, cash even at near nil interest rates is a better risk. For investors with five-year plus horizons, I prefer shares especially those with good free cash flow (and therefore ability to reinvest and/or pay dividends) over virtually any bond investment. This is a classic example of where historic performance is no predictor of future performance!
Why the asset allocation model is broken The US has had a commonly held view that a portfolio 60% shares and 40% bonds is the optimal asset allocation for most retirees. In New Zealand, KiwiSaver default funds are required to hold a minimum of 75% in bonds or cash (soon to be 50%) while the typical balanced fund will have a benchmark asset allocation c. 50% shares and property/50% bonds and cash. As stated in my last article, the standard investor risk assessment process biases many investors, especially those close to or in retirement, towards being a conservative or balanced risk profile many likely preferring this status without fully understanding the longterm return and financial planning implications. The lower return impact on such portfolios is now accentuated by the negative contribution their material allocation to bonds is likely to achieve for at least the next five years. Having been an adherent to the validity of conventional asset allocation
