Register For Our Mailing List

Register to receive our free weekly newsletter including editorials.

Home / 212

Tension as diversified portfolios have lost their anchor

There’s plenty of material in the market about how yields within the aggregate bond indices are either nominally negative or offer negative real returns. It creates problems for investors seeking to achieve a ‘CPI+’ target just by allocating to traditional OECD government bonds as their portfolio’s defensive anchor.

Many Chief Investment Officers at defined benefit superannuation or pension funds wishing to manage their long-term liabilities with a standard diversified portfolio may no longer be able to consider government bonds a strategic asset class. At best, most OECD government bonds could be considered a tactical asset class, one used to buffer the underlying capital during any expected market correction. Their predicament is further complicated by the on/off debate around when meaningful inflation will return.

Where else to invest ‘defensively’?

Frustrated by their inability to access traditional government bond yields at CPI, let alone above, an increasing number of professional investors have either increased their risk budgets within their defensive buckets (sounds like an oxymoron), or they’ve abandoned the underlying bond indices and embraced specific bond issuer risk. In either case, this is indicative of how investors are looking to redefine traditional exposures, albeit while still under the ‘defensive’ umbrella.

But the risk budget must come from somewhere.

There’s always been some friction between bond and equity departments. More recently, much of this friction has come from the fixed income team now consuming a larger portion of the overall portfolio risk budget. Equity teams can come to resent this as they’re usually the ones asked to reallocate some of their risk budget to keep the overall bond allocation fixed at a Moses’ stone-engraved and highly static 40% level. The fixed income teams push out their risk budgets, while leaving the overall total portfolio risk budget static, and the allocation has come out of the equity teams.

In fixed income, especially for active portfolio managers, this has opened up what was previously a dormant and inactive sphere. What wasn’t passively allocated already was predominantly owned by a few big fixed income houses (or in central bank portfolios). Unlike what’s been happening within the equity world, many fixed income investors seem to be moving away from traditional passive. But here too, even the big ETF and index providers have been negatively impacted as investors have either favoured high risk fixed income options, or complete benchmark agnostic fixed income portfolios. Liquidity and capacity constraints have played against the massive size of the major fixed income shops.

Either way, yields on OECD medium and long-term bonds remain at levels that make it too difficult to assist in pension liability immunisation, or for any investor seeking low risk CPI+ returns. As long as this continues, investors will be forced to seek out alternatives within a shrinking bucket called Fixed Income.

Portfolios lose their defensive character

Investors will either have to push out their risk budgets (through individual bond purchases or through higher credit risk), or seek out bundled solutions which deliver risk and return metrics traditionally expected of a ‘defensive’ asset class. Obviously, these moves take portfolios away from their primary role of protecting capital. It’s like anchoring a boat with too short a slack, until it ultimately pulls the vessel under water.

Investing a diversified portfolio in this market is not easy. If it was, then economics would be an exact science over a social one.

 

Rob Prugue is Senior Managing Director and CEO at Lazard Asset Management (Asia Pacific). This content represents the current opinions of the author and its conclusions may vary from those held elsewhere within Lazard Asset Management. This article is for general education purposes and readers should seek their own professional advice.

RELATED ARTICLES

Is 'shaken and stirred' coming? The risky business of bonds

Are you in fixed interest for the duration?

Busting the bond myth

banner

Most viewed in recent weeks

Are LICs licked?

LICs are continuing to struggle with large discounts and frustrated investors are wondering whether it’s worth holding onto them. This explains why the next 6-12 months will be make or break for many LICs.

Retirement income expectations hit new highs

Younger Australians think they’ll need $100k a year in retirement - nearly double what current retirees spend. Expectations are rising fast, but are they realistic or just another case of lifestyle inflation?

Welcome to Firstlinks Edition 627 with weekend update

This week, I got the news that my mother has dementia. It came shortly after my father received the same diagnosis. This is a meditation on getting old and my regrets in not getting my parents’ affairs in order sooner.

  • 4 September 2025

5 charts every retiree must see…

Retirement can be daunting for Australians facing financial uncertainty. Understand your goals, longevity challenges, inflation impacts, market risks, and components of retirement income with these crucial charts.

Why super returns may be heading lower

Five mega trends point to risks of a more inflation prone and lower growth environment. This, along with rich market valuations, should constrain medium term superannuation returns to around 5% per annum.

Super crosses the retirement Rubicon

Australia's superannuation system faces a 'Rubicon' moment, a turning point where the focus is shifting from accumulation phase to retirement readiness, but unfortunately, many funds are not rising to the challenge.

Latest Updates

Investment strategies

Why I dislike dividend stocks

If you need income then buying dividend stocks makes perfect sense. But if you don’t then it makes little sense because it’s likely to limit building real wealth. Here’s what you should do instead.

Superannuation

Meg on SMSFs: Indexation of Division 296 tax isn't enough

Labor is reviewing the $3 million super tax's most contentious aspects: lack of indexation and the tax on unrealised gains. Those fighting for change shouldn’t just settle for indexation of the threshold.

Shares

Will ASX dividends rise over the next 12 months?

Market forecasts for ASX dividend yields are at a 30-year low amid fears about the economy and the capacity for banks and resource companies to pay higher dividends. This pessimism seems overdone.

Shares

Expensive market valuations may make sense

World share markets seem toppy at first glance, though digging deeper reveals important nuances. While the top 2% of stocks are pricey, they're also growing faster, and the remaining 98% are inexpensive versus history.

Fixed interest

The end of the strong US dollar cycle

The US dollar’s overvaluation, weaker fundamentals, and crowded positioning point to further downside. Diversifying into non-US equities and emerging market debt may offer opportunities for global investors.

Investment strategies

Today’s case for floating rate notes

Market volatility and uncertainty in 2025 prompt the need for a diversified portfolio. Floating Rate Notes offer stability, income, and protection against interest rate risks, making them a valuable investment option.

Strategy

Breaking down recent footy finals by the numbers

In a first, 2025 saw AFL and NRL minor premiers both go out in straight sets. AFL data suggests the pre-finals bye is weakening the stranglehold of top-4 sides more than ever before.

Sponsors

Alliances

© 2025 Morningstar, Inc. All rights reserved.

Disclaimer
The data, research and opinions provided here are for information purposes; are not an offer to buy or sell a security; and are not warranted to be correct, complete or accurate. Morningstar, its affiliates, and third-party content providers are not responsible for any investment decisions, damages or losses resulting from, or related to, the data and analyses or their use. To the extent any content is general advice, it has been prepared for clients of Morningstar Australasia Pty Ltd (ABN: 95 090 665 544, AFSL: 240892), without reference to your financial objectives, situation or needs. For more information refer to our Financial Services Guide. You should consider the advice in light of these matters and if applicable, the relevant Product Disclosure Statement before making any decision to invest. Past performance does not necessarily indicate a financial product’s future performance. To obtain advice tailored to your situation, contact a professional financial adviser. Articles are current as at date of publication.
This website contains information and opinions provided by third parties. Inclusion of this information does not necessarily represent Morningstar’s positions, strategies or opinions and should not be considered an endorsement by Morningstar.