Bonds bolster portfolios amid equity collapse

In summer 2023, as gilt yields nearly hit 5%, I wrote that “bonds were back” as a diversifier following a painful period of rising interest rates to bring down inflation.

My argument, alongside that of almost all fixed-income portfolio managers, was that higher yields now gave investors an income buffer if bond prices fell further, and interest rates were high enough that they now could fall if inflation was beaten, which would boost bond prices, even in the event of economic collapse.

• Our Services: SIPP Account | Stocks & Shares ISA | See all Investment Accounts

At the time, the reputation of the 60/40 stocks to bonds portfolio was in tatters. From the start of 2021 to summer 2023, the Bloomberg Sterling Aggregate bond index had fallen 25%, while the Bloomberg Global Aggregate bond index has fallen 10%.

This meant that mixed-asset funds, such as Vanguard’s LifeStrategy range, with the most invested in bonds were the funds that fell the most. Over that period, LifeStrategy 20% Equity fell 15%, while LifeStrategy 100% Equity rose 1%.

• Why diversification is back – and how to do it properly
• The funds delivering under Trump as US shares drop

To recap on the recent drop in equity markets, since 19 February, the S&P 500 is now down 20%, and about 25% in sterling terms due to a weaker dollar. Owners of a global tracker fund, which had around 75% in US equities at its peak, have now lost 21%.

UK shares were initially resilient, but have now dropped 13%, while Japanese shares are 22% off highs and Chinese shares are 19% lower.

Deutsche Bank calculated that the S&P 500 saw its fifth-worst two-day performance since the Second World War, only rivalled by Black Monday in 1987, the 2008 Great Financial Crash and Covid-19.

• Gold investing: what, why and how to invest
• Watch our video: gold: what the mining experts say

Christian Floro, market strategist at Principal Asset Management, says that the size and scope of the tariff announcements overwhelm the trade actions implemented during the 2018 Trade War, bringing average US tariff rates even higher than those seen during the Smoot–Hawley Tariff Act of 1930.

“As a result, heightened worries about economic disruption have erupted. The tariffs represent the largest US tax hike in modern history, and the impact on consumers could be severe. We estimate the resulting hit to US GDP growth at around 2.4%, with more considerable fallout if trade partners retaliate. The odds of a US recession are higher as a result,” he said.

How have bonds performed?

Since 19 February, bonds have been resilient – but not spectacular. However, in a crumbling equity market, just staying still is a big positive to portfolios.

Over this painful period, a gilt tracker fund has risen 2%, sterling investment-grade bonds are up 1.4% and global bonds are up 0.5%.

Much of these gains have come in the past couple of trading days, as equity markets went into freefall following Trump’s “Liberation Day” tariff policies on 2 April.

Chris Iggo, chief investment office at AXA Investment Managers, says that recessionary periods generally mean that bonds outperform equities.

• ISA ideas: around the world in 10 funds in 2025
• Sign up to our free newsletter for investment ideas, latest news and award-winning analysis
• Fund Spotlight: why we like Vanguard LifeStrategy

“Since 1980, US Treasuries have outperformed US equities for more than two consecutive quarters in 1982, 1992, 2001 and 2008-09. These were all recessionary periods. If we are heading into a recession, the odds are that it will not just have been Q1 2025 that saw US bonds outperform US stocks. And if that is the case, the pattern is likely to be seen in other markets too,” he said.

This has been good news for investors who continued to back the 60/40 portfolio. For example, Vanguard LifeStrategy 60% Equity fund is down 8% since 19 February and the BlackRock MyMap 5 D GBP Acc, which has 65% in shares, has fallen 10%.

While not a great outcome, it is far better than the more than 20% drop from a global equity index, or Vanguard’s 100% Equity LifeStrategy option, which is down 13% over this period.

High-yield bonds, however, tell a different story, with Bloomberg Global High Yield index falling 4% over this period. High-yield bonds generally trade more like equities though, as less secure companies (meaning their bonds yield more) are more exposed to economic cycles than investment-grade bonds.

The inflation bogeyman

The unknown factor holding bonds back from rising further is inflation. When central banks set interest rates, they are primarily trying to balance economic growth with inflation. They want to give enough stimulus for economies to grow, but not too much that it leads to inflation.

Ordinarily, if investors were predicting a global recession, then interest rates would be falling around the world, especially now that rates have recently risen and central banks have the “firepower” to cut rates.

However, tariffs are expected to be inflationary, which may tie central bankers’ hands.

Floro says: “With roughly 6% of personal goods consumption tied to imports, the tariffs alone could boost inflation by as much as 1.4%. Core CPI could trend back towards 4% by year-end, reversing progress containing inflation and weighing on real purchasing power.”

The outcome of Trump’s policies could therefore be stagflation – low growth and high inflation – which would be negative for most asset classes.

• Bond Watch: Trump’s trade war could boost UK bonds
• Benstead on Bonds: in a worst-case scenario, can gilts deliver?
• When markets fall, here’s what to avoid doing

Nevertheless, Iggo is bullish on bonds. He says that it is likely that UK and US government bond yields could go below 4%, and below 2% in Europe.

“Central banks have plenty of tools to deal with recession and disinflation if they become material risks,” he said.

However, he flags two risks for bond investors: “At some point, investors would be wise to think about the best protection against longer-term inflation. Equities and high-yield bonds become the go-to asset classes at some point, but again, that is ahead of us.”

Another cost of any response to a global slump will be more government borrowing and steeper yield curves in time, which could lead to losses for longer-maturity bonds.

However, investors can protect themselves with low-duration bonds: “Low (or zero) duration, high-quality cash flow-based assets that deliver a meaningful premium to cash will be preferred to an asset class that runs long-term debasement risk. The appeal of short-duration inflation linked bonds is clear,” he says.