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Trouble ahead for fixed interest investing?

10 March 2020

When it comes to bonds is it time to think outside the box? David Hambidge, director, Multi-Asset Funds, Premier Miton Investors, believes, with potential trouble ahead for fixed interest investing, that it is.

It has been a tough start to the year for equity markets with share prices already under pressure before the sharp falls seen during the last week in February. At the time of writing stock markets have recovered some of the lost ground during the first few trading days of March although with still so much uncertainty surrounding the impact of the coronavirus, investors should prepare themselves for further wild swings in share prices over the coming weeks.

While equity markets have fallen in value, holders of long dated government bonds have enjoyed a rally in prices that have in many cases (including US Treasuries) resulted in yields falling to record lows. This of course will have cushioned the fall from the equity element of the portfolio although there will be a price to pay for this in the years ahead.

As a team we have debated long and hard about the risk and reward implications of fixed income securities that carry very little yield support and their overall usefulness in a portfolio.

Certainly, it can be argued that any asset that has a negative correlation with equities in times of stress is worth owning and during the recent market correction, holding developed market government bonds will have certainly helped.

However, even if one accepts that holding these bonds can still have diversification benefits in times of economic and stock market stress (and we say it depends on the cause of the stress) it is hard to argue that given the very low and in many cases negative starting yields, these assets are going to deliver very poor returns indeed over the years ahead.

Unlike equities where investors will have to make a lot of assumptions when trying to ascertain the likely future return, with fixed income securities such as gilts, basic arithmetic will give you the answer. At the time of writing a 10-year gilt will return around 0.36% per annum over the next decade. Now I accept this may be high versus German bunds and JGBs where investors are paying to own these bonds but the fact is, once inflation and various layers of charges are taken into account, investors in these assets are likely to be significantly worse off in the years ahead.

Given the very poor medium to long-term prospects of long duration government and corporate bonds it is all the more staggering to read about the huge sums that have been invested in products that have significant exposure to low and negatively yielding debt. These types of investment products have benefitted hugely from the collapse in bond yields over the last few years while in some cases a weak pound and strong US dollar has also helped considerably.

If past performance is any guide to the future (which in the case of these products it almost certainly isn’t) then one can understand why so much money has been invested in such funds, especially as the perception is that they also carry a low cost (which is also debatable). However, I strongly believe that when investors are reviewing their portfolios in the years ahead, they are unlikely to think that value has been delivered in any way.

In our multi-asset portfolios our strategy has been to reduce our duration further and take profits from corporate and alternative bond strategies where there would appear little further upside in the near term. Elsewhere we are maintaining equity weightings which means we have been topping up following the sharp February decline and taking profits in early March.

Longer term our view remains that equities will produce far superior returns to bonds although good active management will be the key to providing what our clients perceive as an acceptable return after charges. This will mean having to think outside the box and certainly not adopting a strategy that has resulted in excellent returns over the last three decades but which won’t over the next three.

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