There is no sin but ignorance

Christopher Marlowe, The Jew of Malta

Bonds have played a limited role in the financial independence portfolio so far. Hollowing the examination of the equity portfolio last month, however, it seemed fitting to complete the picture with a detailed look at the development of, and trends in, the bond and fixed interest holdings.

The last detailed examination of the fixed interest and bond components of the portfolio was undertaken in October 2019. This found that the bond portfolio was reasonably well-diversified, broadly index-aligned, and doing its job of providing ballast against equity volatility — even if it had largely arisen in conditions of ‘benign neglect’.

More than six years have passed since that examination. In the intervening period, global bond markets have experienced some of the most dramatic conditions in recent decades. These include the pandemic-era collapse of yields to historic lows, a sharp rate-hiking cycle from 2022 that delivered real capital losses to bond holders worldwide, and a gradual recovery since. The four decade secular bull market in bonds that seemed at risk of ending in 2019 did, in a sense, end — quite violently.

Along the way, some of the key assumptions underpinning the rationale for holding bonds have been tested in ways not seen for a generation.

Recapping the structure and history of the fixed interest and bond portfolio

When the bond portfolio was last examined in detail in October 2019, total bond and fixed interest holdings stood at around $257,000, representing just under 15 per cent of the overall portfolio.

That figure had itself slightly declined from a peak of around $260,000 reached in January 2018.

The chart below tells the fuller story across nearly two decades looking at all fixed interest holdings (e.g. bond holdings and Plenti peer to peer and capital note investments).

A few features stand out immediately in this broad picture.

The period of rapid accumulation from 2013 to 2018 is clearly visible, as new contributions flowed steadily into both Australian and international bond funds. The peak was around January 2018 — the highest absolute level the portfolio reached before the target allocation was reset. This is followed by a long plateau where no significant new purchases were being made.

The dip visible around 2021 into 2023 is wholly not an artefact of withdrawals or rebalancing.

Rather, it reflects the real capital losses experienced across global bond markets as central banks — led by the US Federal Reserve — raised interest rates at the fastest pace in forty years in response to post-pandemic inflation.

A portfolio with duration of around six years would have experienced mark-to-market losses of the order of 15 to 20 per cent at the height of the rate-hiking cycle. This was uncomfortable, though entirely consistent with the known risk characteristics of holding duration in a rising rate environment.

Also visible is the recovery from late 2023, and more strikingly, the significant jump in total holdings through 2025 and into early 2026. This largely reflects the addition of a temporary Plenti asset-backed notes investment of a cumulative $84,000 — discussed separately in the section below — which explains much of the recent uplift in the Australian (red) fixed interest column.

Sighting the instruments: narrowing the focus on to bond holdings

Excluding those Plenti asset-back notes, the ‘bond only’ portfolio currently stands at around $224,000, up from around $221,000 at the start of 2026.

The chart below sets out the total ‘bond-only’ holdings on a biannual basis, excluding Plenti lending platform and capital notes, with the period in of the record highlighted in green.

This shows the pattern of accumulation of the narrower bond holding portfolio. Notable within this is the substantial decline – of around 17 per cent, from early 2021 to early 2023. Note that this graph does not reflect interest income from the bonds, capturing only changes in capital values from 2019.

Except where otherwise indicated, the further detailed analysis below excludes the Plenti holdings, as they are temporary investments deploying surplus capital at opportunistic rates as note issuances allowed. At their expiry and repayment of principal, the intention is to reinvest the proceeds into equity holdings. The intent, therefore is to focus the analysis on the long-term bond portfolio.

This narrower ‘bond-only’ portfolio is held across four underlying Vanguard vehicles: the Global Aggregate Bond Fund (Hedged) retail fund, the Global Aggregate Bond Index ETF (VBND), the Australian Fixed Interest Index Fund retail fund, and the Australian Fixed Interest Index ETF (VAF). These all form underlying sub-components of the legacy Vanguard retail funds owned (the High, Growth, Balanced and Diversified Bond funds).

At its base, the bond portfolio now contains over 14,400 individual bond holdings from 3,289 distinct issuers — up substantially from the over 8,000 individual holdings from 2,200 issuers noted in 2019, reflecting growth in the underlying indices themselves rather than any active portfolio decision.

In foreign ports: the international dimension of bond holdings

The review in 2019 identified that the bond portfolio was far more internationally weighted than the naive 50/50 domestic/international target then in place, and concluded that this was actually close to the right outcome — that there was no compelling case for a ‘home bias’ in Australian bonds.

In 2019 around 70 per cent of bonds (again, excluding Plenti lending for comparability) were held internationally, and 30 per cent domestically.

As the chart below shows, six years later the split has shifted to international bonds representing 81 per cent ($181,668) and Australian bonds at 19 per cent ($42,975).

The overweighting of Australian bond holdings relative to global benchmarks is reduced, but persists, driven by the sizes of legacy holdings in the Vanguard retail funds and their underlying components listed above.

In one sense, this is expected — the 2019 conclusion that no home bias is warranted remains valid, but the 19 per cent Australian bond exposure is still meaningfully above any theoretically optimal global weighting. It is a residue of historical investment decisions not taken with much consciousness at the time, rather than a deliberate choice.

Within the international allocation, country exposure is closely aligned with global bond market weights, with the chart below showing exposure to different jurisdictions.

The United States dominates at 37 per cent of all bond exposure, or approaching around half of all international bonds held. This reflects the size and depth of its capital markets.

For another view, expressed in absolute dollar exposures, the portfolio allocation is set out the chart below.

In combination, bond holdings across France, Japan, UK and Germany approximately equal the total Australian allocation. Around 2 per cent of total bond holdings are in supranational issuers — entities like the World Bank and European Investment Bank.

The long tail of small holdings across Korea, Netherlands, Belgium, Switzerland, Mexico, China, Sweden, Austria and Indonesia provides some exposure to different interest rate environments, yield curves and inflation regimes. This breadth of geographic diversification is one key reason for holding global rather than purely domestic bonds.

Reassessing the stores: the sectoral allocations

The sectoral allocations of the bond holdings are driven by the index weightings.

As can be seen from the chart below Treasury bonds make up a majority of the holdings, with additional holdings across government-related agencies, supranational entities and local authorities.

This means the that portfolio is still, as in 2019, heavily dominated by government debt instruments. These represent about 71 per cent of all bond holdings, marginally above the levels observed in 2019, of around 67 per cent.

By contrast, only around 19 per cent of bond holdings are bonds issued by private entities, split largely between financial institutions and industrial corporates, with a small additional allocation to utility firms.

Around 8 per cent of the holdings are securitised debt, across mortgage or other asset-backed securities. The securitised allocation is dominated by mortgage-backed security pass-throughs at 7 per cent — primarily US agency mortage-backed securities, a large and liquid market with implicit government backing, rather than the kind of complex structured credit that caused significant losses in the Global Financial Crisis.

Average credit quality: reviewing the ratings

One element of the bond holdings not explicitly examined in 2019 was credit quality, or the average credit rating of the securities held.

Noting the exclusion of the Plenti capital notes, the credit quality profile of the bond portfolio is conservatively positioned and skewed heavily toward investment grade securities. The overall portfolio carries an average weighted AA- credit rating, consistent with a portfolio built around the Bloomberg Global Aggregate Index, which by construction excludes anything below the BBB- rating.

The chart below sets out the proportion of the bond portfolio, by credit rating.

Looking at this more closely, AA rated bonds represent the single largest category at 40 per cent, followed by AAA rated at 25 per cent. Only 0.4 per cent is unrated within the bond-only portfolio.

The dominance of AA-rated bonds reflects the heavy weighting toward government and government-related debt from major developed nations. The 14 per cent BBB allocation — the lowest investment-grade tier — is largely corporate bond exposure, and represents the portion arguably most sensitive to credit spread widening in a downturn.

Cross-currents? The equity and bond correlation question

In the earlier review, it was noted that the traditional negative correlation between bonds and equities had not always held, citing 1994 as a year when both fell together. The period since the 2019 review has reinforced this observation.

In fact, the period from 2022 to 2024 delivered the most significant breakdown in bond-equity diversification seen in a generation.

As central banks around the world raised rates sharply to address post-pandemic inflationary forces, both asset classes fell simultaneously and substantially. Global equities declined by around 20 per cent in 2022, while Treasury bonds — normally considered a hedge in equity downturns — dropped substantially in the same year. For the first time since 1958 and 1959, for example, US Treasuries delivered two consecutive years of negative returns. This led to claims around the potential ‘end’ of the traditional 60/40 portfolio in the US, as it recorded its worst year since 1937.

The underlying mechanics of this are worth understanding.

The traditional negative bond-equity correlation holds in environments where the primary macroeconomic threat is weak growth — where falling rates both boost bond prices and prompt a ‘flight to safety’ away from equities. In an inflationary environment, however, both asset classes face headwinds simultaneously. For example, rising rates depress bond prices directly, while higher discount rates and reduced purchasing power pressure equity valuations. When inflation is the dominant risk, the diversification benefit of bonds can at least temporarily disappear.

What this means for a portfolio’s long-term logic depends heavily on the inflation outlook. Research across major developed markets suggests the negative correlation that characterised the two decades from approximately 2000 to 2020 may itself have been historically unusual — inflation had been subdued and anchored throughout that entire period.

In the preceding decades, including the 1970s, 1980s and most of the 1990s, a positive bond-equity correlation was the norm rather than the exception. The post-2000 period, in which bonds reliably acted as a shock absorber during equity downturns, may have been an anomaly rather than a normal condition.

Depending on the resolution of current geopolitical conflicts, and their impacts, there may, however, be possible reason for cautious optimism from the current vantage point in 2026.

Since late 2023, as broadly inflation has receded toward central bank targets, some evidence suggests the stock-bond correlation has been gradually moving back toward negative territory — slowly regaining the diversification properties that help make bonds a valuable portfolio constituent.

The critical question, and one that cannot be answered with confidence in early 2026, is whether the inflationary episode of 2021 to 2023 was a temporary disruption — a pandemic aftershock — or the beginning of a more persistent regime of elevated and volatile inflation. Existing conflicts impacting Iran, the Persian Gulf, and oil and other related exports from the region plausibly argue for the latter.

Yet equally, tariff-driven price pressures, other geopolitical supply chain disruptions, and significant fiscal deficits in major economies all represent potential sources of inflationary pressure that could keep bond-equity correlations elevated.

This is not necessarily a reason to entirely abandon bonds — the portfolio’s primary role remains reducing volatility, and even during 2022 bonds provided more stability than equities over a full market cycle. Yet it is a reason to consider the diversification argument with greater caution than the pre-2022 consensus did at times.

Temporary stores: the Plenti capital notes

The portfolio currently includes $84,000 in Plenti capital notes. This is not invested in their every day direct peer-to-peer consumer lending platform, but is participation in individual unsecured notes offerings made available from time to time to retail investors.

These investments were entered into across late 2023 to late 2024, and are effectively unrated (i.e. below investment grade) exposure to asset backed securities, issued by Plenti, in a process of securitising their own lending. The underlying loans sitting behind the securities are largely composed of car loans.

At the time of the original investment, the capital was directed from cash distributions, in circumstances where the equity portfolio was already above its target. It thus represented a consciously directed placing of excess cash reserves into a higher yielding, and higher risk instrument. It’s impact is marginal, even though it represents around 25 per cent of total bond and fixed interest holdings, it constitutes just 2 per cent of the overall financial portfolio.

These capital notes are likely to mature or be ‘called in’ by Plenti progressively across 2027, after which I shall need to make a determination on the use of the resulting funds. Issuances of similar such notes seems to have slowed or ceased, or be offered at slightly lower rates. The currently planned outcome is reinvestment of these maturing funds into the equity portfolio.

The average 9 per cent yield to maturity is well above that which is available from the Vanguard bond funds — and that premium reflects much higher credit risk in effectively consumer lending, the absence of any credit rating, a single-issuer concentration risk, and 100 per cent Australian geographic exposure that adds no international diversification. It is a fundamentally different instrument from the diversified, investment-grade, globally spread bond portfolio analysed through the rest of this review.

None of this makes it a poor ‘holding’ investment in isolation.

A 9 per cent yield in the current environment is genuinely attractive, and for short-duration consumer lending the credit losses in a mild downturn may be manageable. Its differences and temporary nature means, however, it belongs in a separate category — to be assessed on its own terms as a higher-yielding, higher-risk fixed interest instrument, not as a contribution to the volatility-reduction function the bond portfolio is designed to serve.

Estimating the income potential of bond and fixed interest holdings

Perhaps the most striking change since the previous consideration in 2019 is the potential nominal income-generating capacity of the bond portfolio.

That review noted the difficulty of rationalising future bond purchases when yields were at or near historic lows, and when the primary justification for holding bonds was diversification rather than return. That concern, perhaps accidentally, proved well-founded.

Yields rose sharply from 2022, producing capital losses in the short term but ultimately resetting the portfolio to a far more attractive prospective nominal return.

The yield to maturity figures (albeit estimated in December 2025) tell the story clearly. Vanguard assesses these at 4.64 per cent across both the global aggregate retail fund and the equivalent ETF, and 4.68 per cent across the Australian fixed interest funds.

Using these as a starting point — with the important caveat that yield to maturity represents total return including capital movements rather than cash income alone — the bond-only portfolio of $224,000 at a blended yield of approximately 4.6 per cent would be expected to generate around $10,300 per year in nominal total returns. The income (coupon) component is likely to be in the range of $8,000 to $9,500 annually, with the balance representing capital return as bonds held at a discount accrete toward par value over time.

The Plenti holding adds an estimated $7,560 per year at its 9 per cent yield, bringing the combined fixed interest income estimate to somewhere in the range of $15,000 to $17,000 annually — though this is subject to the timing and repayment dynamics of the underlying consumer loans.

A note of caution is warranted, based on past history.

The earlier review noted the striking variability of actual distributions from the Vanguard funds — one fund swung from $140 to $5,270 in a single year, depending on whether capital gains were being realised and distributed as part of internal rebalancing.

Actual year-to-year cash distributions can therefore diverge considerably from any estimate derived from yield to maturity alone. The $8,000 to $9,500 estimate for the bond-only portfolio should therefore be understood as a reasonable central expectation rather than a reliable annual figure.

What has unambiguously changed since 2019 is the direction of travel.

Then, with yields near historic lows, the income contribution from bonds was minimal and the portfolio was being held almost entirely for its diversification properties. As an example of this the entire bond portfolio delivered average distributions of just under $1,000 per annum across 2022 to 2025.

Today, at a blended yield of 4.6 per cent, the bond portfolio is arguably playing a modest supplementary role — contributing meaningfully to nominal overall portfolio income alongside its long-standing role as a source of stability when markets become volatile.

Even so, some caution is warranted, for income is only one component of return. The effective ‘duration’ of 5.9 years for the portfolio means the portfolio retains meaningful interest rate sensitivity — a one percentage point rise in market yields would produce approximately a 5.9 per cent capital loss, all else equal.

Observations

In an equity driven financial portfolio, the small allocation to bonds is easy to overlook, and has received consistently less focus over the journey to date. This has been reinforced by the poor forward conditions for bond returns over the past decade or so.

Yet bonds represent around 9 per cent, or nearly 1 in 10 of every dollar currently invested in traditional financial assets.

Thus while their capacity to independently deliver significant results at a portfolio level is modest, they can play a role as a hedge against some types of volatility, even if imperfectly. As an example, bonds will tend to suffer in circumstances of higher than anticipated inflation, and, indeed, higher inflation periods more generally.

An example of this is the around 17 per cent decline in the capital value of bond holdings across two years, from 2021-2022, as inflation surged, and interest rates rose globally to address these outbreaks. At critical times, the disappearance of the negative correlation between equities and bond led to compounding losses across both asset classes in times of market strains, notably 2022.

A recently released UBS Global Investment Handbook highlights that bond returns over the past 126 year have been around 1.7 per cent, with gold returns in US dollars of around 1.3 per cent.

An additional consideration over the medium-term is the change in the dynamics of the bond market itself. Put simply, this whole market expands or contracts as public and private financing expands or contracts, and its average credit quality cannot exceed that of its constituent parts. Holding US debt, for example, in times of yawning budget deficits and potentially lower growth is not the same proposition as holding US debt as budget surpluses are in prospect and growth is accelerating in the post-war period.

Whilst in a competitive market, yield adjustments may theoretically account for some of these differences, the real prospect of intended, or unintended ‘financial repression’ policies as markets or central banks absorb higher government debt loadings mean that bonds may entirely lack some of the perceived ‘safe’ qualities that underpinned their core place in a defensive portfolio.

Over the past five years, I have increasingly seen the bond component of the portfolio as simply one element of a broader set of non-correlated assets, serving as a counterpoint to the relatively high allocation to equities. That is, at times, gold holdings may perform some of the functions of a previously dedicated bond portfolio, and perhaps, at other times, Bitcoin might even be held to encompass some important non-correlated diversification compared to a ‘equity only’ portfolio.

From this review, it can be seen that the bond portfolio in early 2026 is potentially in better condition than it has been for some time.

It is more deeply diversified, better yielding, and more closely aligned with market-capitalisation weighted global benchmarks than at almost any prior point in its history. The essential architecture of the bond portfolio established over years, by way of relatively benign neglect through investing through Vanguard’s index funds, has largely delivered this.

And through all of this, the fundamental purpose of the bond portfolio remains what it has always been — not to maximise return in its own terms, but to play a role in the overall performance and stability of the financial independence portfolio. To have a chance of doing this, detailed knowledge of its constituent parts and their exposures is the essential pre-requisite. There is, after all, no sin but ignorance.

Note for readers

Over the last year, there has been a noticeable degradation in the useability of my standard blogging interface. As an alternative, and because I am not interested in becoming a coder, plug-in or website management expert, I have created a rough and ready backup Substack and imported past posts. The formatting of past posts may not be as tidy as here, but should the blog ever seem to ‘disappear’ or cease, it will likely just be a signal that I have switched entirely to Substack and started posting there.

Also, if you are reading this article on a website called “Geldmountain”, please be aware that this and other updates have been reproduced without any contact or permission. Please feel free to view the original site, and subscribe if you wish, here.

Disclaimer

The specific portfolio allocation and approach described has been determined solely based on my personal circumstances, objectives, assessments and risk tolerances. It is not personal financial advice, or recommendation to invest in any particular investment product, security or asset, and investors considering these issues should undertake their own detailed research or seek professional advice.