Bonds are incorporated into portfolios to stabilize against falls in the stock market. They are considered as an asset class that acts independently from stocks so reducing the volatility that an all-stock portfolio would exhibit. However ……
Beware – not all bonds are equal!
The above graph of the performance of the ISHARES ETF Sterling Corporate Bond Fund (SLXX) against the FTSE100 clearly shows both the contrarian response of the corporate bond market at the start of the market crisis in 2007 where there is a 10% fall in the FTSE but a 10% rise in the ISHARE Corporate Bond ETF. However, as the crisis deepens the bond ETF falls nearly 40% compared to a 35% fall in the FTSE 100 – so much for the safety of bonds!
Of course, this ETF was particularly hard hit by being overweight in bank bonds but recessions inevitably result in some companies defaulting on their bond interest and capital repayments, and the anticipation of this is reflected in corporate bond market valuations. Government-issued gilts do provide more protection and the so-called “flight to safety” benefits gilts as shown in the graph below:-
Most (!) governments are perceived as safe havens during market turmoil and this is reflected in the strength of their bonds during difficult market conditions. BUT…….
ALL SOVEREIGN DEBT IS NOT EQUAL!
Emerging market bonds issued by sovereign governments can prove highly volatile. The ISHARES JP Morgan Emerging Markets Bond ETF fell almost as sharply as the stock market during the 2007/8 economic crisis showing a high correlation with the S&P500.
All bonds are clearly not equal. Some such as those issued by governments such as the USA, UK, and the stronger European nations show an inverse correlation to the stock market so can provide an important role in reducing portfolio volatility. Corporate and emerging market bonds are highly correlated with the stock market in times of crisis.
