Portfolio defensiveness – Part 2

October 6 | 4 min read

This article is the second part in a two-part series on portfolio defensiveness. The first part focused on cash, while this part focuses on bonds.

Diversified bonds is an asset class that typically provides defensiveness during unfavourable investment environments. If investors become more concerned about the outlook for economic growth, they will typically anticipate central banks lowering cash interest rates. This results in bond yields falling, providing a capital gain to bondholders. However, if cash rates are already low, as they are today, the capacity for them to fall is limited. This means that the returns from bonds are now likely to be lower during unfavourable investment environments than they have been over recent decades.

We have examined the movement in bond yields during the GFC and the COVID-19 equity crash in the first half of 2020. The results of the analysis are shown in Chart 1. In general, greater defensiveness occurs for larger falls in bond yields (as larger capital gains occur).


* The period for each crisis is defined by the timing of the respective peak and the trough in the US S&P 500 stock market index.

The chart above shows the change in the 10-year bond yield across a range of markets. During the GFC, yields fell by at least 1 percentage point in most markets. This underpinned strong returns from government bonds over this period. However, this was not the case during last year’s equity market correction. While the US 10-year bond yield fell moderately during that period, falls in yields in other markets were small and, in some markets, they rose. This means that the defensiveness of bonds was much less than during the GFC. This is primarily because the levels of cash rates and bond yields were so low just prior to the COVID-19 equity market correction (i.e. they could not fall far).

Another issue related to Diversified Bonds is the risk that inflation rises on a multi-year basis, causing bond yields to rise materially. Under such a scenario, the return from Diversified Bonds would be low and possibly negative. While such a scenario is not our central case, the risk is higher than it has been for a long time because interest rates are very low and COVID-19 has impaired the ability of some companies to deliver goods and services.

While bond yields have risen from their lows of 2020, they remain low and, in some cases, negative – see the chart below. This means that the defensiveness of Diversified Bonds remains low compared to recent decades.


So, in summary, the effectiveness of some aspects of portfolio defensiveness has declined reflecting the fall in interest rates. We take this into account when determining the asset allocation of the multi-asset class investment options. For example, the targeted level of foreign currency exposure may be increased to enhance the level of portfolio defensiveness if there is enough merit in doing so. We may also reduce the exposure to listed equities if the risk of equity markets falling is sufficiently high. Therefore, while some aspects of portfolio defensiveness have declined, adjustments can be made with the aim of helping to reduce the impact of this on portfolio performance.

Investment returns are not guaranteed. Past performance is not a reliable indicator of future returns. This information is general advice which does not take into account your personal financial objectives, situation or needs. Before making a decision about Vision Super, you should think about your financial requirements and consider the relevant Product Disclosure Statement issued by Vision Super Pty Ltd ABN 50 082 924 561 AFSL 225054 at www.visionsuper.com.au

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