Building a resilient retirement portfolio: the role of bonds

For investors who have entered the drawdown phase, income is the central objective.

After more than a decade characterised by low and stable yields, the past five years have marked a regime shift, with a material repricing higher in yields and a corresponding increase in the level of income available from fixed income.

In this context, bonds are being positioned to deliver on their income-generating role. However, the other traditional roles of bonds — namely, volatility mitigation and diversification — have become more challenged.

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Hilary Blandy, manager of the Jupiter Monthly Income Bond Fund, says: “Bonds, and particularly longer duration instruments, have exhibited elevated volatility. The recent repricing in UK and European rate markets underscores the sensitivity of duration to inflation surprises and shifting policy expectations.

“At the same time, the correlation between rates and risk assets has turned more positive in an environment defined by persistent inflation uncertainty and asymmetric risks to growth and policy.”

In other words, bonds are no longer behaving as the reliable shock absorber many retirement portfolios have depended on.

This shift raises a fundamental question for investors approaching or in retirement: what is the role of fixed income in trying to build a resilient retirement portfolio?

Income is back but risk has changed

Blandy says: “Bonds remain a cornerstone of retirement portfolios, primarily through their income-generating capacity.

“However, investors should be mindful that the risk, volatility and correlation properties of fixed income may differ structurally from those observed over the past decade, requiring a more selective and active approach to portfolio construction.”

Yet, this does not diminish the importance of bonds. Instead, it changes how they need to be used.

According to Robin Ellis, director of multi-asset portfolio management at St James’s Place, a well-constructed retirement portfolio today is not about maximising returns, but about maximising resilience.

He argues that structurally higher yields mean bonds should play a larger role than they did five years ago, not just as a source of income, but as a stabiliser of outcomes.

Ellis adds: “For retirees, defensive assets must be capable of delivering positive returns in normal markets and additional upside when equities struggle. High-quality bonds still do this job; commodities, despite their diversification narrative, generally do not.

Two roles, two strategies

Bonds serve two distinct purposes in retirement. The first is income: a predictable cash flow that supports withdrawals without touching the growth engine. The second is stabilisation: dampening portfolio volatility so that a bad equity year does not force a client to panic and realise losses.

That distinction becomes particularly important when translating theory into portfolio construction.

Both purposes are valid, says Jonathan Laws, a senior independent financial adviser at Cameron James, but they point to different types of bonds, durations and credit qualities. Conflating the two is where portfolios get into trouble.

Laws adds: “At Cameron James, we predominantly use medium-duration (around five-year) bonds to dampen expected volatility for those who cannot quite handle the swings in stock markets.

“We also use short-term bonds, such as money market funds, to provide a buffer and manage liquidity needs around withdrawals.”

The limits of fixed income

There is also a more fundamental constraint on how far bonds can support retirement outcomes: their return potential.

As Guy Foster, chief strategist at RBC Brewin Dolphin, notes, the market has been through a period of government bonds yielding mere basis points, during which their usefulness in retirement strategies was limited.

More recently, higher yields have improved the opportunity set. However, he cautions that strategies focused on defined maturity securities covering near-term income payments can still lock in relatively low yields and weigh on returns. Corporate bonds may offer limited additional return for taking on credit risk.

Foster adds: “The role of any asset class must be seen in the context of reasonable judgments about its return potential. The good news is that for bonds, returns are predictable. It takes a bold investor to expect a meaningfully higher return than their yield to redemption.

“Such things are possible, but the range of outcomes is tighter than for other asset classes.”

Diversification conundrum

Crucially, the diversification role of bonds cannot be taken for granted.

According to Trevor Greetham, head of multi-asset at Royal London Asset Management, fixed income still plays an important role, but investors should be cautious about assuming it will always cushion equity risk when inflation is driven by supply-side shocks.

In these environments, yields can rise even as growth weakens, putting pressure on bond prices at the same time as equities derate. As a result, resilience comes from broader diversification rather than a simple equities/bonds split.

Greetham adds: “In practice, that means pairing core holdings with a wider range of diversifiers, including inflation-sensitive exposures such as commodities.

“A tactical approach to asset allocation can also add value, through rebalancing, active management of duration and credit risk, and the use of cash as temporary buffer when both equities and bonds are under pressure.”

A more complex macro backdrop

Much of this shift is being driven by a changing macroeconomic backdrop.

As inflation risks persist, the traditional role of bonds as a diversifier has become more complex. Structural shifts such as geopolitical fragmentation and the build-out of AI are contributing to more persistent inflation and less stable macroeconomic anchors.

One consequence, according to Vivek Paul, global head of portfolio research and UK chief investment strategist for the BlackRock Investment Institute, is that policy rates are likely to remain biased higher than in the pre-pandemic period.

At the same time, rising fiscal deficits and elevated debt levels are increasing the term premium demanded by investors, limiting the ability of bonds to consistently act as diversifiers.

This has direct implications for the traditional roles bonds have played in retirement portfolios.

Paul says: “Retirement portfolios have historically relied on bonds for three key roles: hedging interest rate and inflation risks, generating income, and diversifying equity risk. Their role as a hedge remains broadly intact.

“However, as yields have reset higher, income has become a more significant driver of returns . . . bonds are now more attractive as income generators, but less reliable as diversifiers during equity drawdowns.”

Broadening the opportunity set

One response has been to broaden the opportunity set beyond developed markets.

In this context, Paul says investors should maximise income opportunities across a broad and diversified opportunity set, including global markets, and sees “compelling opportunities” in emerging market debt.

“As a result, retirement portfolios today should lean into bond exposures that enhance income while carefully managing duration risk,” he adds.

Ellis at SJP also notes that emerging market debt can play a valuable role within a defensive allocation, describing it as a useful diversifier to developed market bonds at a time when fiscal dynamics have become less predictable. He adds that, given attractive starting yields, it can be a risk-reducing trade if funded from equities.

Others make a similar case, while emphasising the limits of traditional bond behaviour.

David Jane, fund manager of the Premier Miton Cautious Monthly Income Fund, says that in an inflationary environment bonds can be positively correlated to equities, reducing their effectiveness as diversification tools.

“This is less so for emerging market bonds, where the inflationary and currency picture is less correlated and higher yields can compensate,” he adds.

Sequencing risk and behaviour

There is also a behavioural dimension to how portfolios are constructed, particularly in drawdown, where sequencing risk becomes a key concern.

Brewin Dolphin’s Foster says while decumulation requires managing sequencing risk, balancing assets for income and growth, overall, asset allocation remains the key driver of outcomes.

Additionally, holding excess cash can reduce sequencing risk but may lower long-term returns, potentially leaving investors worse off than staying invested.

Yet even with careful asset allocation, risks remain.

Ellis says, although higher yields mean bonds should play a meaningfully larger role than they did five years ago, they do not solve every problem: “Their primary vulnerability is inflation. Supplementing conventional bonds with short-dated index-linked bonds can improve resilience.

“Ultimately, the biggest risk no asset can hedge is short-term, reactionary decision-making. The best retirement portfolio is the one a client can remain invested in through market stress.”

He warns that excessive complexity risks investors stepping away at the wrong moment, and that behavioural risk matters more than marginal asset allocation decisions.

Even within fixed income itself, the internal dynamics have become more complex.

Jupiter’s Blandy says emerging market debt can expand the opportunity set but introduces additional risks, including currency, liquidity and political factors.

While bonds remain a core diversifier, their reliability has become more variable.

Traditionally, government bonds offered stability while corporate bonds added income through credit spreads, with negative correlation supporting diversification. However, persistent inflation and shifting rate expectations have disrupted this dynamic, with bonds and equities sometimes falling together.

Blandy adds: “This evolving correlation structure presents a challenge to the traditional diversification role of bonds.

“However, it does not negate it. Rather, it underscores the importance of a more deliberate and flexible approach.”

Taken together, these shifts point to a more deliberate approach to portfolio construction.

Managing duration in practice

So what does this mean for structuring fixed income allocations to balance income, stability and risk?

In practice, this often comes down to how duration is managed.

For Laws at Cameron James, duration management is the key lever. Shorter duration reduces sensitivity to rate movements but typically means accepting lower yield.

He says the right balance depends on the rate cycle and the client’s time horizon.

“For most retirement portfolios today, a barbell approach makes sense,” he says, combining short-duration, high-quality bonds for liquidity and stability with slightly longer-duration, higher-yielding bonds for income.

“Credit quality matters too: investment-grade for stability, and a modest allocation to high yield where appropriate.”

A more deliberate approach

A broader, portfolio-level approach is also needed.

Blandy says a portfolio-based approach is essential, with corporate credit remaining a key building block due to its breadth of income opportunities. Combining investment-grade and high-yield bonds can help smooth returns across cycles.

She adds that active management of interest rate and credit exposure is crucial, alongside strong issuer diversification to manage downside risk.

Ultimately, fixed income needs to be considered alongside other asset classes within the overall retirement strategy.

At Cameron James, Laws says the strategy that tends to work well is short to medium-duration bonds for income stability, paired with global equities for long-term growth.

“The biggest mistake,” he adds, “is over-relying on long-duration bonds for income.

“A laddered bond allocation is often more effective than chasing yield at the long end of the curve.”