Part 4 - Bonds

Still bonds?

This post is part of an 8-post series on the construction of my portfolio.

For decades, the classic 60/40 portfolio was the standard for retirement planning. It was a beautifully simple formula: 60% equities for high returns, and 40% bonds to act as a shock absorber. If the stock market takes a dive, your fixed-income bucket cushions the fall.

But the economic shift of 2022 shattered that idea. As inflation surged and central banks aggressively hiked interest rates, both stocks and bonds cratered simultaneously. The long-held assumption that bonds would move inversely to stocks was proven wrong, exposing traditional fixed income as a more dangerous asset class than I had been led to believe.

As a retiree navigating today’s macroeconomic landscape, treating bonds as a passive, “set-it-and-forget-it” safety net does not seem wise. The risk-return profile does not look as good to me as it did before 2022. For that reason, I only want 10% bonds with a maturity longer than a year.

Because traditional long-term EUR government bonds offer measly real returns relative to their duration risk and my complete lack of trust in the Eurozone’s fiscal discipline, I chose:

• 5% Investment grade corporate bonds in EUR for long-term stability.
• 5% EM Bonds for a boost of income, ensuring that taking on long-term risk is actually worthwhile.

The following section outlines my bond selection.

Stable - 5%

I will allocate 5% to:

Table: selected fund

• I like Vanguard EUR Corporate Bond UCITS ETF (EUR) Distributing with ISIN IE00BZ163G84 better than my current choice. Unfortunately, it’s not available via my primary brokers.
• For this category, credit quality and currency are more important than regional allocation.
• Distribution is semi-annually.
• The maximum drawdown of this fund was a nauseating -17.56%. Of course, in 2022.

Now, I am reluctant to invest in this asset class, but I feel I have to. I need assets in my portfolio that are not as volatile as stocks for the first years of my retirement. Here is more info on the risk I am dealing with.

EM Bonds - 5%

And I do 2.5% in each of these:

Table: selected funds

• Please note the difference in credit quality and the high TER compared to iShares Core EUR Corporate Bond UCITS. Having EM bonds is definitely risky, but, for me, the risk-return profile is acceptable in combination with my other assets.
• Both products have a monthly distribution. Nice for an income investor.
• Look what hedging does to the TER. Added almost 30bps. And that is only the visible part.

Inside the box

The two EM bond funds have two obvious differences: TER and currency. However, if you look under the hood, other major differences become visible.

iShares J.P. Morgan $ EM Bond EUR Hedged UCITS

Holds a basket of a little over 610 constituents and enforces strict diversification. It applies a cap on individual country weights of 4.5% to prevent any single nation from dominating the fund. This results in an even geographical spread across Latin America, Asia, and Emerging Europe. It excludes South Korea, classifying it as a developed market. The fund tracks the J.P. Morgan EMBI Global Core Index.

Vanguard USD Emerging Markets Government Bond UCITS

Has around 1 500 constituents. It is heavily concentrated in the Middle East, with nearly 19% of the fund allocated to Saudi Arabia and the UAE alone because its index includes large, state-owned enterprises in these countries. This explains its slightly higher credit quality. It does include South Korea (~3.3%). It tracks the Bloomberg EM USD Sovereign + Quasi-Sov Index.

I also compared their return profiles. The Vanguard fund performs better over almost all time horizons, and I am tempted to go completely with that one. However, the iShares fund provides some of my required EUR exposure. For context, their dividend yields are quite similar (5.58% vs. 5.38%). Compare that to my core iShares EUR Corporate Bond UCITS at a shameful 3.32%.

What is next?

Part 5 covers cash equivalents and gold - like this one, a simple setup with only a few products.