The Big Exchange team discuss whether bonds are a good way to diversify a portfolio...
The Big Exchange team discuss whether bonds are a good way to diversify a portfolio...
The views expressed herein are those of the author and should not be considered investment advice.
When looking to invest sustainably, many retail investors pick an equity fund first, perhaps because there is more information in the public domain so it can be easier to see where your money is making a positive impact. In comparison, bonds are sometimes overlooked.
However, bonds can play a useful role in building a diversified portfolio. What’s more, there has been a significant increase in the universe of bonds with sustainable characteristics and several funds on the Big Exchange focus on this area. Read on to find out more.
Bonds are issued by a company or a government to raise capital. A bond is in essence a loan made by the holder to a company or government for a specified time (typically 1-10 years) in exchange for regular interest payments (the coupon). When the bond reaches maturity, the bond issuer pays back the initial sum invested but, until then, the bond can be bought or sold.
The price of a bond will rise and fall depending on many factors such as company or industry news, interest rate sensitivity and inflation. Its income (or running) yield is the annual coupon divided by the current price of the bond, expressed as a %). This yield moves inversely to price, meaning that when yields rise, prices fall and vice versa. However, it doesn’t include any profit or loss that may arise if the bond is held to maturity.
Equities (also known as shares) give investors a stake in a company, and they pay dividends. Typically yield are lower than on a corporate bond but there can be potential for greater capital returns from equities if the business invested in does well. That said, a dividend can be suspended or cancelled by the company if they want, whereas a bond payment is a legal obligation.
Historically, bonds have been less volatile (the extent to which they move up and down) than equities, and the two asset classes do not always move in the same direction. However, this is not guaranteed and has been challenged in recent years.
An investor with a low appetite for risk may opt for higher exposure to bonds than an adventurous investor who would likely tilt their portfolio more towards equities. Bonds are considered to sit between cash and equities on the risk spectrum; they can fall in value as explained above whereas cash involves no risk to your capital (other than the rare occurrence of bank failures).
It is important to be aware that both equities and bonds have unique advantages and risks. When making an investment decision, it’s essential for the investor to understand the differences to ensure your portfolio composition is suitable to your individual investment goals, time horizon and risk appetite.
A key factor is the interest rate policies of Central Banks. When interest rates go up, bond yields typically follow, meaning the prices of those bonds fall. In contrast, cuts in the bank base rate can present an opportunity to make capital returns if bond prices rise in response.
Another driver is inflation; when expectations are for high or rising inflation, bond prices tend to fall and vice versa. As most bonds pay a fixed coupon, a rise in the cost of living means your income from them has less purchasing power.
The recent trend in interest rate had been downward in most developed economies, as inflation moved towards Central Banks target levels of c2%. The consensus view among economists is for further reductions over the course of 2025 and 2026 which may be positive for investors in the asset class.
That said, some risks remain. The full impact of Donald Trump’s tariff programme is hard to quantify but will likely push up prices of many goods in the event of a global trade war. Another risk is recession (when economic growth turns negative); however, this is usually considered more of a concern for equities as companies may cut their dividends whereas bond coupons are fixed for their life (barring the rare occasion when an issuer defaults).
Although bond investors do not have the same voting rights as shareholders, they can and do engage with bond issuers to encourage commitment to sustainability as well as advocate for positive social and environmental change.
Bonds with sustainable objectives can help drive substantial ESG (Environmental, Social & Governance) improvements and some of the different types are outlined below.
Green Bonds finance projects or activities with positive environmental impacts such as clean energy development and reducing carbon emissions and energy consumption. Examples are wind farms, water purification plants, clean transport, green buildings and infrastructure, sustainable agriculture, and waste management.
Social Bonds finance social projects or activities that achieve positive social outcomes and/or address social issues. These might include affordable housing, education, healthcare, and access to affordable essential services.
Sustainability Bonds finance a combination of green and social projects or activities and may be issued by companies, governments, and municipalities.
Sustainability-linked Bonds are linked to the issuer’s achievement of climate or broader SDG (Sustainable Development Goals) objectives. Progress, or lack thereof, toward the selected targets results in a decrease or increase in the bonds coupon. It is therefore in the interest of the companies issuing these bonds to meet those objectives. Moreover, there are reputational consequences from objectives not being met.
In addition, fund managers may find investment opportunities in ‘unlabelled’ green bonds from issuers inherently aligned to low carbon products and services, such as a renewable energy company. Climate leaders are those companies leading the transition to net-zero carbon emissions in their industries and mindful of any wider environmental impact.
We offer 10 bond funds on our platform with a variety of investment approaches. Ethical bond funds have been around the longest with Abrdn Ethical Corporate Bond launched in 2012. Those with a focus on social criteria such as CT UK Social Bond and EdenTree Responsible & Sustainable Short Dated Bond (launched in 2013 and 2017 respectively) are also well established.
Sustainability focused strategies are on offer from AB (Alliance Bernstein), Liontrust and Pictet. More recently we have seen the arrival of dedicated impact strategies which aim to take advantage of the specialist opportunities, including labelled bonds with measurable outcomes. We currently offer T. Rowe Price Global Impact Credit, Triodos Sterling Bond Impact, and BlueBay Impact- Aligned Bond Fund.
For an all-in-one multi-asset portfolio, the LionTrust Sustainable Future Managed range of funds offers equity/bond portfolios with allocations for different risk appetites.
Please remember that when investing, making money is not guaranteed and your capital is at risk. The value of your fund can go down as well as up. Tax treatment depends on an individual’s circumstances and may be subject to change.
This communication does not constitute investment advice. If you are unsure whether an investment is suitable for your circumstances, you should contact an independent financial advisor.
The Big Exchange (TBF) Limited is a wholly owned subsidiary of The Big Exchange Limited. The Big Exchange (TBF) Limited is an Appointed Representative of RiskSave Technologies Ltd, which is authorised and regulated by the Financial Conduct Authority (FRN: 775330). (RiskSave: 3090)
