The coronavirus pandemic and associated containment measures continued to weigh on the global economy in Q2. The UK economy had already suffered its worst quarterly contraction on record during Q1, with negative shocks to output across all sectors. This was partially mitigated by both monetary and fiscal stimulus. We expect a worse contraction in Q2 as most of the containment measures were implemented over this period.
In the euro area, output also slumped over the quarter as businesses shut down and households were under lockdown. Policymakers attempted to alleviate adverse shocks to the labour market by implementing furlough and short-term working schemes, in addition to extra quantitative easing. Effective containment of the virus led to many euro area countries easing lockdown restrictions significantly from the middle of May.
The US experienced a sizeable economic slowdown over Q2. The shock was broad-based across manufacturing and services sectors. Policymakers met this with an unprecedented level of fiscal and monetary stimulus, which financial markets welcomed. However, this did not fully mitigate the loss of millions of jobs as many firms closed down over the lockdown period.
More recently, as some states have begun to reopen non-essential businesses, new virus outbreaks have appeared in the western and southern states, reducing the chances of a quick recovery.
After its relatively strict lockdown, activity in China began to recover during the last quarter. As new virus cases diminished, high-frequency activity indicators rose strongly in May and survey data suggested the recovery continued into June.
However, there are lingering headwinds going into Q3 as new outbreaks in cities including Beijing have led to a disruption in manufacturing and construction activity.
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The value of investments, and the income from them, may fall or rise and investors may get back less than they invested. Past performance is not a reliable indicator of future results.
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What should investors do in response to these developments? Many investors change their portfolios in a bid to take advantage of the latest news. However, it’s very difficult to time these changes effectively.
In practice, shifting your portfolio in response to short-term events may lead to little more than increased trading costs.
It’s easy to be swayed by the latest developments in the markets or the economy, manager ratings or the performance of an individual security or strategy. However, instead of getting caught up in the investment noise, we believe that we stand a better chance of success if we remain focused on the things that we can control.
Our Investment Beliefs guide our principles for investment success.
Our Investment Beliefs
Vanguard Lifestrategy Q2 2020 Performance vs Benchmark
Vanguard Lifestrategy 5 year Performance Chart
Performance shown is cumulative and includes the reinvestment of all dividends and any capital gains distributions. The performance data does not take account of the commissions and costs incurred in the issue and redemption of shares. Basis of fund performance NAV to NAV.
All performance is calculated in GBP.
Past performance is not a reliable indicator of future results.
Source: FE Fund Info as at 30 June 2020.
Diversification: Not all bonds are made the same – why it pays to be boring with your bonds!
Why holding good quality bonds is crucial in a market downturn
Over the last ten years or so, many ‘investment experts’ have been calling the end of the bond bull market. This has been mainly due to the threat of rising interest rates and inflation, low liquidity levels, and low bond yields.
Whilst we agree that the outlook for ‘decent’ returns from bonds is not exactly favourable, we do argue that bonds should not be held for market-beating returns in the first place.
As the returns from bonds has been diminishing over the last few years, it has caused many investment managers to look at and invest in more risky bonds (high yield) in their search for market-beating returns for this part of their multi-asset portfolios.
But with this comes with a problem!
High yield bonds or, ‘junk’ bonds as they are more commonly known, are almost as volatile as equities. Yes, they do have higher yields and the potential for higher returns, but that’s because they carry significantly more risk. In times of market volatility, they will not provide the safety net that good quality government or corporate bonds might.
When it comes to holding bonds as part of our portfolios, we like to be boring.
Boring means that we like our funds to hold good quality government and corporate bonds. Often cited as ‘safe havens’ in market downturns, they are spread across different geographies and will act as a safety net in volatile markets.
Nothing highlights this philosophy more so than what has happened with bond markets this year to date.
The below chart shows, in brown, the Vanguard Global Bond Index Fund. This fund is in our portfolios and holds a broad mix of high-quality government and corporate bonds across the globe.
The yellow line is the IA global equity sector average return, and the green line is the IA sterling high yield bond sector average return.
In a nutshell, this demonstrates that high yield bonds, that are still classified as defensive in an asset allocation model, show the same characteristics as equities when a market downturn happens. And, on top of that, they do not recover as much when equites bounce. It’s double trouble!
A portfolio of high-quality bonds demonstrates the defensive elements we want from our bond holdings. This, in turn, provides us with a more consistent total return and the ability to keep invested and on track to achieving our goals.