Are the bonds in your portfolio doing their job?

Bonds are often used in portfolios to even out risk and provide protection from the whims of the equity market. For a long time, one of the safest places to be within bonds has been US treasuries. These investments have offered a reliable way to make modest returns without taking on too much risk.

But in recent years, US treasuries have experienced  volatility, particularly for UK investors, as the value of the US dollar relative to sterling has made a strong impact on returns. Treasuries are up 5.4%* in sterling terms on an unhedged basis, compared with 3.2%* for domestic US investors in the past year to 7 July. This means that over 2% of the difference is due to currency fluctuations. While this has worked in favour of UK investors this year, currency fluctuations can just as easily detract from returns, introducing additional volatility to what is generally considered a stable asset class.  

There is, however, always the option to hedge US treasury exposure as well, which removes the currency element.

Over the past five years, unhedged US treasury exposure would have been preferable for UK investors because of the overall strengthening US dollar. But it also would have been a much less steady ride. We can see this by tracking the performance of the Bank of America 1-10 year US treasury index from 7 July 2021, giving us a five-year time horizon. During the mini-Budget in September 2022, the return of US treasuries in sterling terms rose above 17% from July 2021, because of the crashing value of sterling against the US dollar. But by July 2023, US treasuries had lost all of that growth and more, leaving them at a negative return since July 2021. Those with a hedged US treasury exposure would not have benefited from the stronger US dollar and weaker sterling. As a result, returns remained negative until spring 2025, and are just now climbing towards a 5% return*.

Neither scenario is what bond investors are searching for. Either they had to weather a long period of negative returns, or deal with wobbly performance in an area designed to be stable.

For UK based investors, the current environment of a less predictable US dollar and a lower US government yield curve may mean that treasuries struggle to look appealing compared to other types of bonds. For example, although they come along with higher risks, global high yield bonds have returned more than 7% in the past year, in sterling**.

These investments are riskier and taking a closer look at how much opportunity remains in these sectors, as well as remembering the role they play in your portfolio, is crucial.

Is there still opportunity in high yield?

Even though default rates are low across high yield companies, they don’t have the same levels of security as treasuries. Equally, while high yield bonds have been a fruitful sector, investors need to consider how much room they have left to perform in the current economic cycle.

Remember, the future return profile of bonds operates very differently to equities. While equities, theoretically, have unlimited growth potential, bonds have limits to their growth potential from both their fixed income payments and their fixed maturity dates.

For example, let’s imagine you bought a high-yield bond worth £100 that is issued with a 10-year maturity horizon, with a coupon of 7%. Every year you would be paid £7, and at the end of the 10 years, you’d also get your initial £100 back. So, you'd earn £70 from the bond (before fees) over its life. However, bonds are traded in the market every day, causing their prices to fluctuate. As a result, the return an investor can earn depends not only on the coupon rate, but also on the initial price paid for that bond.

If the bond is out of favour at point of purchase, you'll make more than 7% per year (assuming the company comes good on its repayments). This projected amount that you earn on a bond, or a bond fund, is referred to as the yield to maturity.

Bond vigilantes explained: how markets can push interest rates higher

Let's say you bought a bond on a discount (say at less than £100), and in the first five years of this bond’s lifespan, the yield to maturity ends up being closer to 10% each year, much more than its 7% coupon. If you were investing in equity markets, this opportunity for return could be very enticing, perhaps indicating strong growth and attractive forward opportunities in the company.

But when it comes to bonds, there’s a cap on how much growth can occur. Because a bond's future cash flows are largely fixed, strong past performance often reduces future return potential. A new investor looking to buy your bond now would likely have to pay a higher price than you originally did, yet they will receive the same remaining coupons and principal repayment. As a result, the yield available to them is lower than the 10% yield that was available when the bond was trading at a discount.

What this ends up meaning is that in bond markets, there’s less potential for the yield to keep rising after a period of outperformance. People tend to recognise that strong performance and then are willing to pay more for it, which depresses the yield. So, there’s a good chance that investors looking to benefit from the strong returns that high yield has offered over recent years may have already missed the boat.

What low-risk options remain for portfolios?

For investors that are comfortable on the lower end of the risk spectrum, money market funds may still be an appealing option. In the past year, the sector has averaged a 4% return. In the past three years, short term money market funds have averaged a 4.7% return annually, bolstered by high interest rates. But this falls to 1.9% over a 10-year view, due to the ultra-low interest rates in the market in preceding years***.

The performance of these funds is largely dependent on interest rates, which often react to inflation. But for those who are looking for returns higher than interest rates, there are some more creative alternatives.

This could include strategic bond funds, which allow the fund managers flexibility to invest in the parts of the bond market where they see the best opportunities. The Artemis Strategic Bond fund is one example on AJ Bell’s Favourite fund list.

*Source: FE fundinfo ICE BofA 1-10 year US Treasury as of 7 July 2026
**Source: FE fundinfo IA £ high yield sector as of 7 July 2026
***Source: FE fundinfo short term money market sector average as of 7 July 2026