A few weeks ago in this newspaper’s Money section, my colleague Ian Cowie wrote an interesting piece describing his decision to move his pension completely out of bonds.
He was unhappy with the way his pension scheme’s age-related asset allocation (life-styling in the jargon) was shifting him towards bonds and away from equities. I was struck by the article because, while I agreed with his logic, it struck me as what they used to call in Yes Minister a “brave” decision.
The argument against the traditional move into bonds as you approach retirement is broadly this: after a 30-year bull market, government bonds are too expensive; if you don’t intend to buy an annuity at retirement, you don’t need to protect capital in the run up to that date; and, touch wood, if you face a longish retirement, you want to be in an asset class that hedges against inflation rather than in one that will be clobbered by it.
Ian’s column struck a chord and I promptly went to check my own pension’s exposure to bonds. I shared his desire not to be the last fool hanging on to my fixed-income investments as the Great Rotation drove everyone else into the warm embrace of the equity market.
As it happens, my retirement savings are 15pc bonds, 80pc equities and about 5pc cash, which, according to the traditional rule of thumb for pensions, makes me a bit less reckless than Ian, but still very much on the racy side of prudent. The main reason why I have decided to stay with my bonds, is that the passing years are teaching me not to try to second guess the future. In an uncertain world, I prefer to put my eggs in a variety of baskets even if I’m happy to disregard the guidance that you should take your age from 100 to arrive at the optimal proportion of bonds in your portfolio (51pc as you’re asking).
The second reason is that the nature of the two bond funds I own goes a long way in my opinion to mitigating the risks of holding bonds at this stage of the cycle because they are both actively managed and unconstrained by a benchmark.
This sounds a bit technical, but it is important because it reflects massive changes that have swept through the bond market since the financial crisis. The most significant of these has been a 70pc reduction in the availability of AAA-rated risk-free bonds since the downgrades of
the US, France and, most recently, the UK. This matters because it has had the effect of significantly increasing the price of safety, driving the cost of US Treasuries, Bunds and Gilts higher and their yields lower. To many of us, these safe havens now represent not a risk-free return, but a return-free risk.
The changing risk landscape means that the bonds of companies such as Exxon Mobil, Johnson & Johnson (NYSE: JNJ - news) and Microsoft (NasdaqGS: MSFT - news) , are now deemed more secure than those of the country in which they are domiciled. Given the way in which companies have strengthened their balance sheets and built up cash reserves during the past five years, while governments have picked up the tab for the banking crisis, that seems reasonable.
The bond funds I am invested in have the flexibility to invest in these super-safe corporate bonds and to shun government bonds entirely if they wish because they are unconstrained by any benchmark and can actively choose the best available issuer regardless of whether that is a company or a country, in the developed world or an emerging market.
I have disliked benchmark-driven equity investing ever since I saw how it filled investors’ portfolios with technology, media and telecoms stocks in 2000 just when they were most expensive and riding for a fall. Passive investing in bonds is just as pernicious why would anyone choose to invest in the debt of the most heavily indebted countries and companies?. Another reason to be flexible when it comes to bond investing is that different parts of the bond market behave very differently. In 2010, for example, the difference between the best performer (high-yield bonds) and the worst (government bonds) was 47 percentage points.
I’m keeping my small exposure to bonds because, while they are never going to match the interest-rate driven returns of recent years, they do provide some reassuring diversification to my equity-dominated savings. But I’m only prepared to do so because I trust my fund manager to squeeze the safest and best returns out of a much more challenging environment for bond investors.
Tom Stevenson is an investment director at Fidelity Worldwide Investment. The views expressed are his own. He tweets at @tomstevenson63