David Thomson: What is outlook for bonds now mini-budget crisis has passed?

It was not all Mr Kwarteng’s fault; bond prices had already been falling in 2022 due to rising inflation levels caused by excess Covid policy stimulus, a post-pandemic consumer spending spree and the Russian invasion of Ukraine which saw energy and food prices spiral upwards.

However, his plans spooked the market and the fallout was sufficient enough for the Bank

of England to reverse its stance on quantitative tightening and step in to buy bonds and support pension funds that had become forced sellers

of bonds.

However, a change of Chancellor and Prime Minister later and the UK Government bond market is showing some stability and the Bank

of England has again been selling government bonds successfully.

It is also true that the fall in government bond prices this year may signal a fundamental reversal of fortunes for bond markets in general compared with recent years when the interest they provided was consistently falling and bond values rose.

As central banks start to engage in quantitative tightening instead of easing this will create a headwind for many assets; although as we have seen in the UK this strategy may well be reversed in times of market strain.

However, the primary role of government bonds in an investment portfolio is not necessarily to drive returns but to act as a stabiliser.

Historically, they have helped to keep portfolios on a relatively even keel by smoothing out returns that can be especially important if you are close to retirement or relying on your investments to cover your living expenses.

Thanks to the dependable income streams they offer, government bonds normally tend to be less volatile than shares; even if that has not been

the case this year. In addition, bond prices often move in the opposite direction to share prices, especially during periods of recession and this also helps smooth portfolio returns.

Bond and share prices do sometimes fall in tandem, as we have seen recently and also during the Covid 19 market slump of March 2020.

In 2020 the effect was short-lived and it will be interesting to see if government bonds recover

as quickly this time given that they normally perform well during a recession.

If investment returns are lower in the near future as some are predicting, now that central banks move to sell bonds into the market and soak up cash, it is likely bonds will not be the only assets affected.

Investors should probably be wary of any solution that promises an easy escape from this low-return environment via alternative strategies, such as property, which may appear to offer an attractive return but which may come with additional liquidity risk.

The last thing investors should do is abandon the principles of good asset allocation. There is not a silver bullet alternative.

Prudent portfolio construction is about striking the right balance between different

types of assets that historically offer different levels of potential risk and return and then diversifying these investments in line with

your objectives.

The further away an objective is, the more an investor is able to tolerate market swings and hence younger people can invest in higher-risk shares and less government bond exposure

is required.

The older people get, the more their time horizon shortens and the more urgent is their need for lower-risk portfolio stabilisers combined with prudent rates of withdrawal to ensure they do not run out of funds.

There is no one-size-fits-all solution. Investors should dial up or down the risk-return profile of their portfolios depending on their investment goals, investment horizon, risk tolerance and

a set of realistic expectations for asset returns (net of costs).

David Thomson is chief investment officer at VWM Wealth Planning.