De Bunsen says quantitative easing has inflated the asset class to such an extent that its incremental removal – known as tapering – could dramatically hit bond yields as the market becomes increasingly illiquid. Concerns over the so-called “bond bubble” bursting have dissipated in 2014 as yields have once again dropped. However, de Bunsen says investors shouldn’t become complacent as another large-scale sell-off – such as the one seen in May last year – could be on the horizon.
“So much money has gone into the asset class,” de Bunsen said. “The problem is lots of this money has gone into fixed income funds and when it starts coming out – which it will at some stage – there is a very real risk that prices of bonds shoot down, because there aren't the potential buyers to match the sellers.”
“We still have a bit of high yield exposure but we don't like interest rate risk, so we have trimmed that and dipped our toe into emerging market debt, which is looking better value.”
He added: "In this environment, we are being forced up the risk curve to try and generate a positive real yield; that is a warning sign that you may not get the income that you are expecting from bonds."
Bond funds have had a difficult time over the past 12 months, after hints from the Fed in May 2013 that it was planning to gradually reduce the size of its monthly fiscal stimulus programme caused a pan-asset class sell-off.
According to FE Analytics, several funds in the IMA Strategic Bond, Corporate Bond and UK Gilt sectors suffered significant losses during the "taper tantrum" in May and June of last year.
The average Strategic and Corporate Bond funds managed to regain their losses following on from the correction.
However, IMA UK Gilts finished the year down more than 5 per cent and the IMA Global Emerging Market Bond sector was hit even harder, down almost 10 per cent at the end of 2013.
Performance of sectors in 2013
Source: FE Analytics
De Bunsen is not the only manager who is bearish on the outlook for bonds. Invesco Perpetual’s Paul Read, who manages the £5.5bn Invesco Perpetual Corporate Bond fund, recently told FE Trustnet bond managers will struggle to make decent returns even if interest rates stay at historic lows.
De Bunsen says unattractive bond yields have made equities more attractive than bonds for income investors.
“Last year we said that all the money that had flowed into bond funds was going to come out and go into equities, because the economy was starting to heal and equities would be the most sensible place to be in that environment.”
“However, we don't think we have had a great rotation at all, more like a mini rotation. There’s a lot more to come.”
“Also, dividends from equities are a better source of income because they tend to grow with nominal growth in GDP and therefore offer some inflation protection. However equities can be volatile, which is a bit unsettling and dividends can be cut.”
De Bunsen says alternatives can help to diversify and limit risk within a portfolio without decreasing return potential and are therefore an attractive prospect.
He added: “However, a lot of caution needs to be applied to investing in alternatives as a lot are simply illiquid and can give a false sense of diversification.”
The manager says he is biased towards value rather than growth stocks in developed markets. He says he has been heavily rotating out of small and mid caps into larger caps recently. He is also holding a large proportion in cash due to his reluctance to buy bonds.
De Bunsen joined the Henderson Multi Asset team in December 2012.
One of the team’s best performing portfolios has been the five-crown rated Henderson Multi Manager Diversified fund. According to FE Analytics, it has been the best performing portfolio in the IMA Mixed Investment 0%-35% sector over five years with returns of 70.32 per cent.
Performance of fund vs sector over 5yrs
Source: FE Analytics
The fund, which yields 2.8 per cent, currently only has 32 per cent in bonds, with the lion’s share of that weighting dedicated to flexible fixed income funds such as Jupiter Strategic Bond and Henderson Strategic Bond.
De Bunsen and his team also hold close to 20 per cent of the fund in cash.
FE Alpha Manager Marcus Brookes, who manages the £1.4bn Schroder MM Diversity fund, says he has become increasingly bearish in the past 12 months. He says the equity market is at risk from a correction and there are no attractive alternative opportunities in bonds. As a result, he has been upping his exposure to absolute return funds and is sitting on a very high level of cash, currently at 32 per cent.
“We are putting money towards more market-neutral products, because we are struggling to find managers who are very bearish,” he said.
“In a world where we think fixed income is stretched, and being multi-asset investors, there are some pretty difficult implications. One option is to go into a high cash holding, as we have done, and hold bonds as they tend to be negatively correlated [to equities], but this isn’t currently the case.”
“Normally it is the bond part of your portfolio that provides that safety when that leftfield event happens, but we are having to look elsewhere.”
De Bunsen and his team also hold close to 20 per cent of the fund in cash.
