The last six months have been very unusual for investors, with what Mr Carpenzano described as a “perfect storm” of circumstances. Traditionally, a portfolio of bonds and shares can provide balance, with these securities offering the opportunity for growth while also potentially preserving assets during difficult economic times. However, he explained that this balancing mechanism broke down after Russia’s further invasion of Ukraine.
“Bonds are perceived as being complicated, and this is partly true, but fundamentally these are a very straightforward instrument,” he said. The investor lends money for a fixed period to private or public organisations, as well as governments, for which the investor receives a regular payment (yield) before receiving back their initial investment when the bond matures. However, there is always a risk that part, or all, of the investment may be lost if the borrower goes bust or the government decides not to reimburse (defaults).
“We started from a situation with bond yields having been very low for many years,” Mr Carpenzano explained, “but then central banks became concerned about inflation and started to increase interest rates quickly in reaction.” It was the speed and amplitude of increases that spooked investors. Bonds that were created years ago, before the war in Ukraine and pre-Covid, were being traded in a revolutionised economic and financial environment.
“As interest rates rose quickly, bond prices went down quite dramatically, and so they offered no protection from what happened in the equity market,” he said. Stock markets fell due to rates being higher, but also because economic growth started to slow. “There was no place to hide,” said Mr Carpenzano.
He is concerned that this experience is repelling investors from considering bonds. “When we speak to clients all over the world, there is scepticism, with them saying ‘bonds didn't protect me during the storm, so maybe I should keep everything in cash.’” He points to evidence that cash may give a false sense of security. “It is true that there is less volatility with cash in your bank account, but you also don't see how inflation erodes these savings considerably,” he said. This is more flagrant now with inflation pushing towards double digits, but even with inflation of, say, 2-3%, when that compounds year on year this adds up to considerable erosion in real terms. Over a longer timeframe, bond market pricing should theoretically adjust to inflationary concerns.
Understanding investment objectives is key. “All investments are risky, by definition, as there is always risk in every position taken,” Mr Carpenzano explained. “So rather than thinking that bonds are about making a safe investment, one should probably think in terms of the objective of the portfolio,” he added. That means assessing when the investor wishes to see a return (for retirement, to pay university fees, etc) and individual attitudes to risk. “Bonds provide diversification and can offer an aspect of capital preservation, despite volatility, and more importantly, can provide income over time,” he said.
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