Bonds have had a difficult start to the year as yields rose sharply and values plunged, and while pension investors with significant time ahead of retirement can shrug off the plunge, others may feel a sharper pinch, says Richard Whitehall.
The head of portfolio management at Aegon says the "significant negative returns over the last two years" in fixed income, standing at -22 per cent for a broad gilts index (September 2020-August 2022) and -15 per cent for a broad UK investment-grade index, could hit those close to retirement more because they are typically allocated a higher percentage of fixed income holdings.
By September both the UK and US 10-year yields were above 3 per cent, the first time in a long time for the gilt, though not high by historic standards. This means values have suffered, though the rising yields also offer new opportunities.
In a Q&A with FTAdviser In Focus, Whitehall explains what the market movement means for pensions and why Aegon has started to add fixed income back into its portfolios.
FTA: Bonds are having a rocky time at the moment. What does this mean for pension portfolios? Are you concerned about the use of bonds in pension portfolios?
RW: For pension investors who have some time before they retire, this may have had only a relatively small impact, given allocations to fixed income in such funds are not usually extensive.
In contrast, pension investors closer to, or in retirement may well have been harder hit as allocations to bonds are usually greater in such portfolios.
That said, most pension investors have, at the same time, benefited from strong equity markets (despite challenges in 2022), with broad world equity indices returning c24 per cent over that same two-year period.
Looking forward, the now higher yields mean that expected returns from bonds are more attractive, and within our portfolios we have been comfortable to add back into bonds, having been underweight previously.
FTA: What is your typical allocation to fixed income in your pension portfolios?
RW: The share of the portfolio in pension products varies significantly depending on how long people have until retirement.
Where people have seven years or more until they retire, typically more than 75 per cent of assets are invested in equities, with the rest in a mix of UK and overseas corporate and government bonds, or cash.
We believe fixed income has an important role in pension portfolios.
Over the long term, we expect the asset class to deliver a positive return with a lower level of volatility than equities, helping to manage risk with multi-asset pension funds.
The higher yield now available in bond markets is helpful for return expectations. Moreover, government bonds still offer the potential to perform well in a number of scenarios that are more challenging for equities.
FTA: Has your strategy for using fixed income in pensions changed at all given the sell-offs?
