My portfolio is currently heavily weighted toward growth assets (i.e. shares). It’s been suggested my risk profile would suit moving 30% into more conservative assets such as bonds. While I understand the basis for the recommendation, my experience with bonds (through ETFs such as GOVT and IAF) recently has been negative. With interest rates rising, would it be sensible to simply move some of the portfolio to cash accepting say 1% interest rather than invest in bonds? Or is there some rationale for investing in bonds?
A: The theory is that bonds are negatively correlated to equities – that is, when equity prices rise, bond prices fall (and vice versa), so that when combined in a portfolio, you can achieve an optimal return without taking too much risk.
Now, this doesn’t always happen as we have seen recently, with both equity prices and bond prices falling (when bond yields go up, bond prices fall). This tends to happen in the early part of rate increase cycle.
My sense is that long bond yields have further to rise (we haven’t really tested the 2.0% level in the US), so I wouldn’t rush into buying long-duration bond funds (such as GOVT, IAF or VAF). I would keep the money invested in short-duration bonds, term deposits or cash. This means almost no return – but also no risk of capital loss. At some stage in the cycle, I would move into long-duration bonds – but I think you are too early.