A higher yield is appealing. But if bonds are there to support a portfolio when equities struggle, what risks come with that extra income?
Corporate bonds offer a way to earn additional yield by lending to companies. They also introduce exposure to those companies’ financial health, which can become particularly relevant when economic conditions deteriorate.
Our latest adviser research, Short-dated global credit: The role of corporate bonds in a defensive portfolio, examines that trade-off. It explores how maturity changes the picture and what a modest allocation to short-dated corporate bonds could contribute to a broader bond portfolio.
For financial advisers only. This research is intended for financial advisers and must not be distributed to retail clients.
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A global aggregate bond allocation typically includes government, corporate and other investment-grade bonds. Adding a separate corporate bond holding therefore increases an exposure that is already present.
That makes the portfolio question more specific: how much company debt should the defensive allocation hold, and how does it work alongside the other bonds?
Investors generally demand additional yield to lend to a company rather than a government of stronger credit standing with a similar repayment date. This difference is known as the credit spread.
It reflects factors including the risk of default, how easily the bond can be traded and wider market conditions.
The additional yield does not guarantee a higher total return. If confidence in the issuer weakens or investors demand more compensation for risk, the bond’s price can fall. Corporate bonds can therefore come under pressure at the same time as equities.
Short-dated bonds are closer to repayment. They generally have lower duration, meaning their prices are less sensitive to changes in market yields than those of longer-dated bonds.
That can help limit the effect of rising yields. It also means less potential benefit when yields fall. And shorter maturity does not remove the credit risk associated with lending to companies.
“Short-dated” describes the maturity of the bonds. It does not mean the investment is free from risk.
The paper compares short-dated and all-maturity global investment-grade corporate bonds with aggregate bonds from October 2018 to September 20261.
It examines both the inflation-driven bond sell-off and the COVID-19 market shock. These episodes help distinguish the effects of rising yields from concerns about company finances and market liquidity.
The comparison highlights why a defensive allocation needs to be assessed across different conditions. A characteristic that helps in one environment may be less helpful in another.
Past performance, including simulated past performance, is not a reliable indicator of future results. Bonds are exposed to interest rate, credit and liquidity risk. Currency hedging reduces, but does not eliminate, currency risk. Investments and their income can fall as well as rise, and investors may receive back less than they invested.
The research also tests a hypothetical portfolio that replaces 15% of a global aggregate bond allocation with short-dated corporate bonds, rebalanced monthly2.
It examines the effect on returns, volatility, losses and recovery, alongside the periods when the blend fell behind. This is a historical simulation, rather than the performance of a Timeline portfolio.
The central consideration is how increased credit exposure and reduced duration work together. The paper assesses that combination while retaining a focus on the role of high-quality government bonds when equities are under stress. Diversification does not guarantee against loss.
Research for financial advisers
Explore the role of corporate bonds in a defensive portfolio, including the historical comparisons, market stress analysis and simulated 85/15 allocation.
Important information
This blog is prepared exclusively for use by financial advisers and must not be distributed to retail clients. It does not constitute advice, an offer or a solicitation to invest.
Compiled from sources believed to be reliable. Any views, opinions or estimates expressed, including any forecasts or forward-looking statements, constitute the author’s judgement at the time of writing, are not guaranteed and are subject to change without notice. None of Timeline, its directors, officers or employees accepts liability for any loss arising from the use hereof or reliance hereon or for any act or omission by any such person, or makes any representations as to its accuracy and completeness.
Past performance, including simulated past performance, is not a reliable indicator of future results. Index returns exclude investment costs, and indices cannot be invested in directly. Simulated results do not represent returns an investor could necessarily have achieved. Investments and their income can fall as well as rise, and investors may receive back less than they invested.