In Focus: Fixed income  

How to diversify in bonds exposure

  • To communicate how to use bonds to diversify portfolios
  • To explain why portfolios benefit from diversification
  • To explain the risks in bonds exposure
CPD
Approx.30min

Such a limited data set cannot capture all possible outcomes. This is being reinforced in 2022 when a sharp decline in equity price was accompanied by a decline in government bond prices, including Tips.

We must therefore take great care when using historic data and be especially wary of applying too great a probability to any single scenario, instead weighing the impact and probabilities of a variety of scenarios. 

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What role do bonds play in diversification?

As we build these scenarios, it is clear that bonds can play various roles due to the variety of their structure and underlying exposure.

Bonds can diversify inflation as well as deflation risk, not to forget recession risk as well, which comes from excessive growth.

The investor is consequently not limited to owning one type of bond for diversification but can own a variety to meet the need for diversification in the various scenarios. 

Yet, despite this range of investment options, we need to remember that the uncertainty of the future means that we cannot hope for every outcome to reflect our expectations.

Rather, we hope to use the weight of probabilities to create a return path that will help the end investor reach their goals.

Bonds are the tools that help us to shape that path and provide a sure footing for our investors. 

Dan Kemp is global chief investment officer at Morningstar

CPD
Approx.30min

Please answer the six multiple choice questions below in order to bank your CPD. Multiple attempts are available until all questions are correctly answered.

  1. What risks should investors consider when using bonds to diversify a portfolio, according to the author?

  2. Why, according to the author, should portfolios be diversified?

  3. Having diversification on portfolios is the same thing as having variety. True or false?

  4. What, according to the author, gives the best indication of how asset classes will behave?

  5. Bonds can diversify inflation as well as deflation risk. True or false?

  6. When weighting scenarios, it is important to avoid overconfidence in the data. True or false?

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  • To communicate how to use bonds to diversify portfolios
  • To explain why portfolios benefit from diversification
  • To explain the risks in bonds exposure

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