For all but the most adventurous of our clients, the portfolios we construct will include a holding of passively managed fixed interest securities, partly because this asset class can help to contribute to portfolio yields, but primarily because it is proven to disproportionately reduce overall investment risk and volatility.
Within this approach, the focus is on high-quality securities and the pursuit of a variable maturity strategy, typically including bonds with a maturity date of less than 5 years because whilst shorter-dated bonds are proven to help lower overall portfolio volatility, the increased volatility associated with longer-dated securities does not tend to be compensated for by significantly higher returns, as the table below illustrates:
Fixed Interest Securities and the Increased Volatility of Returns Over Time, 1964-2008, (US)
|
1 Month Treasury Bills |
6 Month Rolling Treasury Bills |
1 Year US Treasury Notes |
5 Year US Treasury Notes |
20 Year US Govt. Bonds |
Annualised Compound Returns |
5.69% |
6.46% |
6.66% |
7.50% |
7.87% |
Annualised Standard Deviation (Volatility / Risk) |
1.34% |
1.71% |
2.32% |
6.24% |
11.10% |
(Note 1: 'Standard Deviation' is a mathematical term which in the context of investing essentially means volatility / risk. The greater the 'Standard Deviation' figure, the higher the volatility of returns.)
(Note 2: Data kindly provided by Dimensional Fund Advisors. Past performance should not be regarded as an accurate guide to the future.)
In addition, in the interests of diversification and therefore further risk reduction the bond holdings will have a global perspective, but crucially, with exposure to foreign currency and movements in exchange rates being 'hedged' away, because, as with all aspects of our approach to investing, we feel it is important to eliminate risk factors such as these which academic research shows do not contribute to an increased expected return over time.