Learning from the bond crisis of 2022

Government bonds are one of the safest asset classes you can invest in.  They’re known as Treasury bonds, or Treasurys, in the US, or gilts in the UK.  But it’s wrong to assume that bond funds will never fall in value.  A video on the Bloomsbury Wealth YouTube Channel.

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Transcript: Robin Powell & Joe Wiggins/ Behavioural finance expert

RP: Government bonds are one of the safest asset classes you can invest in.  They’re known as Treasury bonds, or Treasurys, in the US, or gilts in the UK.  But it’s wrong to assume that bond funds will never fall in value. Sometimes they do, and 2022 was a rare example.

JW: We had a confluence of events in the summer of 2022, which had profound implications for investors and for bond markets, and the gilt market in particular. So we had an environment that was defined by rising inflation and rising interest rates after a prolonged period of a moribund environment for government bond yields. Added to that, we had a UK-specific shock around the mini-budget, and the new and temporary leadership in the UK, which saw gilt yields spike dramatically over a very short space of time.

RP: But, as a behavioural expert, Joe Wiggins says there’s an important lesson to learn from what happened to bonds in 2022.  It’s this: as investors, we tend to focus on risks that are salient and recent, and neglect risks we haven’t experienced before, or at least not for a long time.

JW: For investors in bond funds or mixed asset funds where they’ve got significant allocation to bonds, we’ve been through a period of equanimity for gilts and for Treasurys for such a long period of time – they’ve moved lower and they’ve been closer to zero for a significant period – and we haven’t seen them as assets that can go through difficult and risky periods as well. And then we have a shock: we see very significant losses in certain areas of the bond market and that comes as a surprise to us. So we need to be aware, when we’re thinking about risks and our own behaviour, that things can happen in markets that we haven’t experienced before, that are different to the common models that might be used by asset managers or advisers as well. We need to be aware of our behavioural response to risk.

RP: So what happened in the bond markets in 2022 doesn’t mean that you shouldn’t invest in bonds.  It’s simply a reminder of why it’s so important to diversify.

JW: Diversification is about our inability to predict the future. If we knew the future, then we’d invest in one asset or one security because you’d know that it would be the strongest performer. But we don’t. So we’re diversified across assets, so we’re able to withstand difficult and unexpected periods that we might experience through time. The other point is that behaviourally, we need to be prepared for any investment strategy to go through difficult and challenging periods. Even if a strategy we’ve been investing in has been very effective for a decade or more, there will inevitably be periods when it is more challenging. We need to be prepared for that and behaviourally comfortable withstanding those challenging periods, because generating returns – generating high returns through time – is about accepting some level of risk and behavioural discomfort.

RP: And that’s the bottom line: all investors are bound to feel discomfort from time to time.  If you’re diversified, there will always be parts of your portfolio that are performing less well than others.  But, by spreading your risk, you are greatly reducing the chances of things going badly wrong.

Disclaimer — The information in this video does not constitute advice or a recommendation, and you should not make any investment decisions on the basis of it. If you do however require advice please do not hesitate to contact Bloomsbury Wealth.