Fixed interest performance update and its impact on the Governed Range

Published  13 July 2023
   4 min read

Fixed interest assets, especially government bonds, have had a very volatile period over the last 18 months.

This has meant that lower-risk Governed Portfolios and Governed Retirement Income Portfolios (GRIPs) have underperformed higher-risk portfolios as they hold a higher proportion of fixed interest assets. Understandably, this may be concerning, particularly for more risk-averse clients, as well as for those who are already taking an income from their pension or are planning to do so soon. To help you support these clients, we look at what’s been happening, what we’ve been doing to help mitigate the impact and what this means for them.

What’s been happening with fixed interest assets?

Generally, fixed interest assets are seen as more stable and less risky than assets such as equities and commodities, as well as providing a stream of income. However, recently they’ve had a very volatile period, especially government bonds. Events such as Covid, the war in Ukraine and the monetary policy decisions made by Liz Truss’s short-lived government have all unnerved the market and had an adverse impact on bond performance.

This situation has been exacerbated by a continuing period of rising and persistently high inflation that appears to defy market expectations each time figures are released, causing even more uncertainty in financial markets. The Bank of England is trying to control inflation by increasing interest rates, realistically the only tool available to it. But financial markets tend not to react well to shocks and the fact is that the price of bonds will almost always fall when interest rates are rising. In this unprecedented market environment, these factors combined to create a perfect storm where bond performance has been extremely poor and fixed interest assets fell more than equities.

In 2022, UK gilts were down over 20%, their worst performance since 1974, and across the Atlantic US bonds suffered their worst yearly loss in local market terms since 1926. It was this poor performance that resulted in the lower-risk Governed Portfolios and GRIPs suffering unexpectedly larger falls than the higher-risk portfolios. This is because the lower-risk portfolios include a higher proportion of bonds than the higher-risk portfolios, which have higher proportions of traditionally more volatile assets such as equities and commodities.

What we’ve done to help mitigate the impact

This is where diversification and asset allocation come in. The Multi-Asset team at Royal London Asset Management can make short-term tactical changes to the Governed Portfolios and GRIPs to increase or reduce how much is invested in different asset classes to add value over the short to medium term. In 2022, the portfolios benefited from the team’s tactical decisions to maintain a reduced allocation to bonds for most of the year.

What this means for your clients

Although it may not seem like it just now when looking at recent fixed interest performance, the rationale for having a diversified portfolio and thinking longer term still holds true. Having a diversified portfolio means that the impact of a single asset class or group of asset classes performing badly is likely to be mitigated somewhat by the performance of other types of assets as different assets tend to perform differently during the different stages of the economic cycle.

With the Governed Portfolios, the Multi Asset team uses an approach called the Investment Clock to link the returns of different asset classes to the wider economic environment, with global growth and inflation being key indicators of what stage we’re at in the economic cycle. This is important as the returns of different asset classes can vary greatly depending on where we are in that cycle.

Last year, with global growth slowing but inflation staying stubbornly high, the Investment Clock moved into stagflation – a stage of the economic cycle which tends to see negative performance from both equities and bonds. So poor performance from bonds wasn’t unexpected, although the extent of the poor performance was much worse than usually experienced.

Where you have clients who are concerned that their pension investments have taken a tumble just before they plan to retire, it’s a good opportunity for you to illustrate the value of your advice. You can show them how they can navigate the current challenging market conditions and the options that could work best for them and their circumstances. For example, if they have other sources of income or cash savings, could they hold off taking money out of their pension for the time being to avoid locking in losses?

The outlook for fixed interest

On a positive note, with yields having risen to attractive levels, we believe the outlook for bonds is looking brighter over the longer term. A better market environment is likely to follow if higher interest rates tip the UK into recession, with higher yields continuing to provide an income stream that can offset some of the capital losses.

Fixed interest assets have served us and our customers well over the long term, including during other periods of market volatility. And with yields now at attractive levels, we believe they still have an important place in diversified portfolios like the Governed Portfolios and GRIPs.

Remember that the value of all investments can go down as well as up, and your clients may get back less than they paid in. Past performance isn’t a guide to future performance.