Four jobs get given to a bond portfolio, and each one fails in a way worth knowing before you accept the mandate.
What do bonds do for a portfolio?
The first is diversification against equity risk, which works because a growth scare pushes equities down and high-quality government bonds up. It fails whenever the shock is an inflation shock rather than a growth shock, because inflation lifts the discount rate for both assets at once. Calendar 2022 is the standard exhibit: a broad US investment-grade bond index and the US large-cap equity index both fell by double digits in the same year, roughly thirteen and roughly eighteen percent respectively. (Both figures are approximate and should be traced to the index providers' own factsheets before use; checked 2026-09-08.) A hedge that fails precisely in the regime you most wanted it for is not worthless, but it is a conditional hedge, and the condition needs to be written down.
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The second is regular cash flow, and this one is more reliable than the first. Take the immunised rupee book built in Worked Example 1: ₹63.856687 crore of assets throws off ₹4.560258 crore of coupons in its first year, which covers 38.002150% of that year's ₹12.00 crore payment without selling anything. Coupon income is the least glamorous property of a bond and the one a treasurer relies on most, because it arrives on a date printed in a document.
The third is inflation protection, which a nominal bond does not provide at all. A five-year rupee government bond yielding 7.20% earns a real 1.611374% if inflation runs at 5.50%, and a real 0.186916% if inflation runs at 7.00%. Roughly 95 basis points of real return disappear for every 100 basis points of inflation surprise, which is what "no protection" means quantitatively. Index-linked bonds provide the protection directly, and their price is visible: a US nominal ten-year yield of 4.30% against a real yield of 1.85% implies a breakeven inflation rate of 2.405498% by the exact ratio (1.0430 / 1.0185) - 1. Subtracting the two yields gives 2.45%, which is 4.45 basis points too high, and the shortcut is fine for a conversation and wrong for a trade.
Can bonds match a known liability?
The fourth job is the one that organises everything else in Fixed-Income Portfolio Management I. A bond portfolio can be built to defease a known obligation, so that the assets and the liability move together and the surplus between them stops mattering. No other asset class can do that. An equity portfolio cannot be matched to a pension promise in any meaningful sense, because equity has no maturity and no contractual cash flow, and the whole liability-driven industry exists because bonds have both.
Where the fourth job fails is worth stating with equal force. A matched book still carries credit risk, still carries the risk that the liability itself is remeasured on a different basis than the assets, and still carries the model risk of whatever discount rate the actuary or the regulator imposes. A plan can be perfectly hedged against the market's rate and completely unhedged against the rate its own accounting standard requires it to use.
That last sentence is worth a minute before you move on. Almost every disagreement between an actuary and an investment committee reduces to it.