It has been a rollercoaster ride for government bonds recently. Once the dependable backbone of a balanced investment portfolio, their credentials have been seriously tested. 

Bonds: once the great diversifier
Many seasoned investors will confidently say that “government bonds and shares are negatively correlated.” This means that when equities rise, bonds fall, and vice versa. At least that is the conventional wisdom. 

Of course, if that relationship of negative correlations holds, that is a very powerful tool for a multi-asset investor. The investment journey is automatically "smoother," as the ups and downs in a portfolio’s equities and bonds offset one another to some degree.

But is this conventional wisdom really true? And does it still hold today? Let’s test this, through the lens of a few market regimes.  

First, let’s take a journey back to the 1960s and 1970s. In that period the relationship between the equities and bonds was neutral. When equites went up, it was a toss-up whether bonds went up or down. It would be fair to say that in terms of a portfolio diversifier back then, bonds did not really help much. More to the point, they delivered lower returns than cash in that 20-year period, because of high inflation (1). With hindsight we can say cash would have been the better companion to equities in a classic 60/40 (60 per cent equities, 40 per cent bonds) balanced portfolio. 

Enter the 1980s. From 1980 right through to the turn of the millennium, bonds and equities became positively correlated. In other words, when equities delivered negative returns, more often than not, so did bonds. While it may not be the best combination, we think the market was still somewhat scarred from the negative bond returns from the prior decade. In short, it took time for trust in bonds to be regained, even if bonds delivered decent returns in this regime. It is fair to say balanced portfolio investors had a mixed experience.  

The millennium turned, and with it the fortunes of bonds turned. From 2000 to 2020 bonds really came into their own. In what we can now say was a “golden age” for bonds, they reliably zigged when equities zagged. Even better, bonds delivered handsome total returns too, as inflation and interest rates ground lower (2). Many investors built portfolios (and their careers) around this dependable dynamic; they simply knew that when equities fell bonds would come to the rescue. This became something of a recognised truth.  

This is why what has happened more recently has been such a shock. 

What has changed since 2020?
The Covid pandemic was the first big test. As markets panicked in early 2020, bonds initially did their usual job – rallying as equities slumped. That comforting negative correlation was still there, boosted by low inflation and generous central bank support.

Then inflation came knocking – hard. Energy prices soared, supply chains got tangled, and prices across the board shot up. In the UK, inflation peaked north of 10 per cent (3). The Bank of England, along with other central banks, responded by aggressively hiking interest rates. In just over a year, UK interest rates jumped from 0.1 per cent to 5.25 per cent (4).
 
As a result, bonds and shares fell together. Rising bond yields (which means falling prices) put pressure on both asset classes. Suddenly, that tried-and-tested 60/40 portfolio mix didn’t feel so balanced anymore.  

But was this not just a one-off reset in 2022. We have had a few brief spells since where bonds have looked useful again as diversifiers – especially when inflation expectations have cooled – but by and large, that classic diversification benefit has been missing in action.

Fast forward to 2025, and we have seen yet more volatility – this time sparked by US politics. Again, any diversification benefit from bonds was short-lived. It was not long before worries about inflation and fiscal discipline sent yields soaring and with it bond returns tumbling.  

Remaining resilient
Earlier this year, we reduced our exposure to equities, ahead of the worst of the market falls. However, instead of piling into bonds we chose to diversify into gold and cash. Because while bonds still have a role, we are being pickier than ever.

Bonds are far from being obsolete, but we need to rethink how and when they work best. They are not always the perfect diversifier. They are not always negatively linked to equities. And they do not always offer shelter in a storm.

If the past few years have taught us anything, it is that we cannot take the old bond rules for granted. In fact, the "old rules” relate only to a relatively short period of time. We were treated to a golden 20-year period with bonds delivering positive real returns, excess returns versus cash, and a negative correlation to equities. With hindsight we can say markets have been spoilt, and investors got used to it.  

But the world has changed and so have markets. In response, we need to be more thoughtful, more selective, and maybe a bit more sceptical about some of the assumptions of the last 20 years. Looking further back in history may well offer a useful guide.  

Footnotes

1,  https://www.federalreservehistory.org/essays/great-inflation
2,  https://www.federalreservehistory.org/essays/great-recession-and-its-aftermath
3,  https://www.ons.gov.uk/economy/inflationandpriceindices/bulletins/consumerpriceinflation/october2022
4,  https://www.bankofengland.co.uk/boeapps/database/Bank-Rate.asp