Bonds are a significant aspect of many investment strategies - for all the reasons discussed in our Asset Allocation section.

However, after deciding how much to allocate to bonds (as part of the initial asset allocation process) you still need to decide which bonds or which bond markets to actually invest in.

This process involves three stages:

Choices at each stage will depend on whether the portfolio is to be actively or passively managed.

Active management

Active management involves trading bonds, so they won’t be held in a portfolio for very long. An active portfolio seeks to profit from bond price changes created by interest rate fluctuations or by credit rating changes.

So a portfolio must focus on the most liquid markets (large size issues with high trading volumes), looking for bond issues which are about to change in value. The major government markets in USD and EUR are the most attractive to trade.

Passive management

Passive management is a ‘buy and hold’ strategy, so there isn’t so much need for liquidity. This gives passive portfolios a wider choice of markets and currencies than actively traded portfolios.

Managers look for the highest returns ( identified by yield to maturity) for a given investor risk profile which meet an investor’s future cashflow needs.

Portfolio returns – whether from an active or passively managed portfolio - will be compared against a benchmark index, usually made up from the relevant currency’s government bond returns.

A portfolio which is not simply holding government bonds will have a higher risk profile, and so should deliver correspondingly higher returns.