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Vanguard: ‘Bonds are back’ – How to tap into the asset class

Vanguard: ‘Bonds are back’ – How to tap into the asset class
Paloma Kubiak
Written By:
Paloma Kubiak

There’s no denying that 2022 and 2023 were punishing years for bond investors. But investment giant Vanguard shares the bold conviction that ‘bonds are back’.

Like something out of one of Arnie’s movies, Vanguard is putting its weight behind the asset class, with the investment strategy team saying “bonds are back”.

The truth is, its conviction in the asset class as an important diversifier in investment portfolios hasn’t wavered, even through the torrid years of 2022 and 2023.

In fact, the investment behemoth expects UK bonds to deliver annualised returns of around 4-5% over the next decade, compared with the 0.8-1.8% expected at the end of 2021.

And this is from “lower-risk investments”.

For global ex-UK bonds (as at 31 Dec 2023), it expects annualised returns of around 3.6-4.6% over the next decade, compared with a forecast of 0.8-1.8% two years ago.

James Norton, head of financial planners at Vanguard in Europe, says that over the past couple of years, there were a lot of commentators – not the first nor the last – to say the balanced 60/40 portfolio is dead; that there isn’t a role for fixed income; that this strategy is “doomed to failure” and investors need to be smarter with their money.

“We didn’t believe that for a minute. If Vanguard thought balanced portfolios were dead, we would have said so; we would have changed things, but we didn’t believe that to be the case”, he says.

However, Norton acknowledges it was a very difficult time for people with fixed income, but adds that “fixed income is doing its job again”.

“If clients are in the right level of risk to suit them, then riding out these periods of volatility – which we know happens again and again – is the right thing to do.

“Our view is that bonds have always been part of a globally diversified portfolio to get that level of risk right.”

He says that bonds are adding balance and safety to portfolios, “and for the first time in 20 years, it’s giving a really good income to support portfolios”.

Norton explains that markets were correcting from very low – “artificially low” – interest rate environments, “which is unparalleled in hundreds of years of history” to a more normal interest rate environment.

“And that more normal interest rate environment – if you’ve been through the pain of bond prices falling – has actually meant that bonds are now giving a really good return again,” he says.

How to tap into the bond asset class

Vanguard says that when talking about bonds, you need to make sure you’re buying the right kind of bonds, and understand the reason for holding them, i.e., balance the risk of equities.

“To reduce risk, they need to be high-quality bonds – that’s critical”, he says. High quality refers to Government bonds/gilts, high quality corporates or from governmental organisations.

The popular Vanguard LifeStrategy funds (20/40/60/80) all have bond exposure with global diversification.

Investors can also buy individual bond funds such as the Global Bond Index Fund, which gives investors exposure to thousands of underlying holdings around the world.

On duration, Norton says “we don’t play around with duration”, so it has some shorter-dated and some longer-dated bonds, which for experienced investors gives them the optionality on that.

However, Norton says: “For most investors, we say buy the index, the global aggregate index that is buying the short, medium and long term. Like with equities, don’t try and time it”.

Three bond fund ideas

Darius McDermott, managing director at Chelsea Financial Services, shares his three bond fund picks:

1) BlackRock Corporate Bond

Backed up by the vast resources of BlackRock, lead manager Ben Edwards has a consistent track record of exploiting inefficiencies across the bond market. Not only has this fund delivered strong performance since Edwards became manager, it has been achieved while taking on significantly less risk than the average fund in the sector.

2) M&G Emerging Markets Bond Fund

Emerging market bonds defied expectations in 2023, delivering strong returns despite headwinds like high interest rates, geopolitical tensions, and China’s sluggish growth, and we see many potential tailwinds for the market in 2024.

Within this space, we favour the M&G Emerging Markets Bond Fund. Led by the highly experienced Claudia Calich, the fund benefits from her deep understanding of this complex asset class and her proven track record of success.

3) GAM Star Credit Opportunities 

The fund targets consistent high income by strategically investing in the “junior debt” of investment-grade companies. Managers Anthony Smouha and Gregoire Mivelaz, who bring over 50 years of combined experience, prioritise a long-term buy-and-hold strategy focused on strong credit quality, which adeptly balances income generation with portfolio stability.