This feature is brought to you in partnership with Vanguard
For advisers and investors alike, the question is no longer whether bonds have a role to play, but how that role has evolved in today’s market. To explore this, IFA Magazine’s Deputy Editor, Jenny Hunter, spoke to Kelly Gemmell CFA, Senior Manager, Fixed Income Product Management at Vanguard, about how the firm is thinking about bonds today, what has changed in the fixed income landscape, and where opportunities may lie for investors.
For much of the last decade, bonds struggled to excite investors. Ultra-low interest rates meant yields were slim, and many portfolios leaned more heavily towards equities to generate returns. But the landscape has shifted dramatically in recent years. Rising interest rates transformed the fixed income environment, bringing bonds firmly back into focus for portfolio construction.
According to Gemmell, while the environment around bonds may look very different, their fundamental role within portfolios remains largely unchanged. “Bonds have been perceived as that ballast in your portfolio to protect the portfolio, which typically consists of equitylike assets during periods of volatility,” she says.
That stabilising role is something investors have relied on for decades. While bonds are not designed to eliminate risk entirely, they can act as an important counterbalance during periods of market stress. “You can’t expect fixed income to protect the portfolio to the full extent all of the time,” Gemmell explains. “But typically, they would move less than your equities most of the time, and in a typical recession-like environment, when your equities tend to perform particularly poorly, that’s when your fixed income should step in to support the portfolio.”
A very different yield environment
While the role of bonds may feel familiar, the yield environment today looks very different from the one investors experienced over the past 10 to 20 years. “What’s interesting about now is that central banks have the scope to cut interest rates, given where interest rates are at, currently,” Gemmell says. “If, in line with our base case, the conflict in the Middle East is resolved in the next quarter or two, we could continue to see UK inflation fall. We’re expecting headline inflation to move more towards the early twos by the end of this year.”
This backdrop gives central banks room to manoeuvre if economic conditions deteriorate. “If we did experience a period of economic hardship, the central banks would have the firepower to act.”
But perhaps the most noticeable shift is simply the income available from bonds today. Yields have risen significantly compared with the low-rate era that dominated the previous decade. “If we look at UK investment grade, that’s yielding about 4.7% right now,” Gemmell explains. “That’s a gross yield, but it’s rather more attractive than what we’ve seen over the last 10–20 years.”
The difference this can make over the long term is substantial. As Gemmell points out, even relatively small differences in yield can compound meaningfully over time. “If you are lucky enough to have £250,000 to invest, and you invested every single year with 3.3% (the average over the past 10 years) versus the 4.7%, it would be quite a different outcome. It would be the difference between earning £95,000 on your investment or earning £146,000.”
For advisers helping clients to plan their retirement, that gap could translate into a noticeably different lifestyle. “If you think about retirement, that’s quite a difference in the type of retirement you would be able to live with and spend on.”
Understanding the risks
Of course, fixed income investing still requires careful consideration of risk. Two key drivers underpin bond returns: interest rates and credit spreads.
“You have two big drivers of your fixed income returns,” Gemmell explains.
At the moment, credit spreads appear somewhat tighter than historical averages. “You’re getting about 70 basis points uplift. The average is more like 1.2%, so I cannot say investment grade is particularly attractive from a valuations perspective.”
Even so, many investors continue to allocate to credit markets. “We still like investment grade from the idea that that is still a yield uplift, and if it’s compounding over time, it can also drive important uplift to your returns over the long run.”
“The conclusion here is that protection piece, that ballast in the portfolios has remained in play, but what’s been different is the yield environment.”
Navigating global uncertainty
Global events also continue to shape the behaviour of bond markets. In recent years, geopolitical developments have repeatedly reminded investors how quickly sentiment can shift. “We have seen a lot of geopolitical volatility, and that will impact different asset classes differently,” Gemmell says.
Energy markets, safe haven assets and government bonds can all respond rapidly as investors reassess risks. “With the events of early March, with the conflict in the Gulf, you can see moves in your safe haven assets, but particularly in oil. You will then see that translate into your bond portfolio in various different ways.”
However, history suggests many geopolitical shocks tend to create short-term volatility rather than long-term market shifts. “If you think about those big war-type events, typically, you would see a spike up in assets and then a bit of a reversion to the mean. The big risks are the exceptions, the tail events, and we run scenarios to try to understand those.”
In this environment, diversification remains the most effective way to manage uncertainty. “We tend to suggest diversification as being the primary avenue for managing that risk,” Gemmell says. “Because ultimately, if you have an active or an index- based equity portfolio, they could both be impacted.”
Innovation in fixed income
Despite being a vast market, fixed income has not always been seen as particularly innovative compared with equities. Part of that perception stems from the complexity and sheer scale of the bond universe. “If you’re thinking about equities, maybe take a FTSE or similar type of index, you’ve got over 4,000 securities,” Gemmell says. “But if you’re comparing it to a similar type of index on the fixed income side, you’d be looking at an index like Bloomberg global aggregate with over 30,000 securities.”
Many of these securities are still traded over the counter, and the market has historically remained dominated by active management. Yet this complexity also creates opportunities. “If you’ve got 30,000 securities, there’s an awful lot of potential to diversify.”
For asset managers with the scale and research capabilities to navigate this universe effectively, it opens the door to identifying value across a wide range of issuers and markets.
A different approach to active management
Within Vanguard’s active fixed income approach, consistency is a key priority. Gemmell describes the philosophy as being “True to Label”. “For me, it’s really about that long-term consistency.”
Rather than pursuing dramatic outperformance, the aim is to ensure the asset class continues to behave as investors expect. “If, for example, fixed income is your diversifier and the manager has taken on a lot of risk, and it starts to correlate increasingly to your equities, that can mean when you really need fixed income to step in, that role is jeopardised.”
Instead, the focus is on steady alpha generation without overwhelming the characteristics of the asset class itself. “We want funds that deliver on their fixed income name, but adding consistent Alpha that’s not dominating performance.”
Scale also plays an important role. Vanguard manages around $2.8 trillion in fixed income assets, allowing the firm to leverage broad research coverage, trading relationships and issuer insights across a vast opportunity set. Those relationships help inform investment decisions across thousands of securities and markets, while also helping the team secure efficient trading execution for investors.
As Gemmell explains, the aim is to use that scale in a way that benefits clients. “We want to be a house that’s known for that consistency, whether that’s consistently tight tracking on the index side or consistent and repeatable alpha on the active side.”
She adds that the firm’s investor-first philosophy sits at the centre of everything it does. “We really value our clients,” Gemmell says. “You feel very close to the adviser and their clients and conscious of their outcomes and how you could impact them.”
The return of bonds
After years of low yields and limited excitement, bonds are once again attracting renewed interest from investors and advisers. Higher income levels and the potential for central bank easing have reshaped the fixed income landscape.
While risks remain, the fundamental role of bonds within diversified portfolios has endured. As Gemmell puts it, “That protection piece, that ballast in the portfolios has remained in play.”
The difference today is that investors are once again being rewarded for holding such exposure as part of a well-diversified investment portfolio.
To find out more about Vanguard’s fixed income strategies, click here
Kelly Gemmell, CFA, Head of Fixed Income Specialism, PRD Europe, Vanguard
Kelly heads Vanguard’s Fixed Income Product Specialism team in Europe. Her team covers active and index mutual funds and ETFs.
Kelly joined Vanguard in 2022, having previously worked in discretionary portfolio management at Morgan Stanley and Credit Suisse. She analysed equity and fixed income securities and managed equity, fixed income and multi asset portfolios. She also led the development of the sustainable direct securities platform for both equity and fixed income securities.
Kelly holds a bachelor’s degree in business management from Kings College London, is a CFA charterholder and holds CFA Institute certificates in both ESG investing and Climate and Investing.
