They have performed much better than absolute return funds, which are principally designed to give investors an insurance policy when sentiment takes a turn for the worst.
Given that the bulk of UK investors’ portfolios are (rightly or wrongly) invested in the UK equity market, we looked at which funds have done best during drawdowns of more than 10 per cent in the FTSE All Share since 2007.
Between 31 October 2007 and 3 March 2009, the FTSE All Share fell a whopping 45.79 per cent. Our data shows that the average fund in IMA UK Gilts and IMA UK Index-Linked Gilts sectors actually made money – 11.49 and 2.96 per cent, respectively.
IMA Global Bonds did even better, making over 18 per cent on average.
Performance of sectors and index Oct 2007 – Mar 2009
Source: FE Analytics
As well as performing strongly, gilt funds operated with very low volatility over the period.
Among the best performers over the period were M&G Global Government Bond, Allianz Gilt Yield and M&G Gilt & Fixed Interest Income.
UK government bonds also held up very well during smaller downturns between 2010 and 2013. Between 9 April 2010 and 2 July 2010, the All Share fell over 14 per cent, but the average UK Gilts fund shrugged this off with positive returns of 5.43 per cent. Every other sector bar IMA UK Index-Linked Gilts and IMA UK Corporate Bond lost money over the period.
Again, volatility was minimal during this time.
Performance of sectors and index Apr – July 2010
Source: FE Analytics
The same trend was also evident during the eurozone summer sell-off in 2011, when the All Share plummeted by more than 15 per cent. Between 8 July and 19 August 2011, IMA UK Gilts was far and away the best performing sector with returns of over 6 per cent. Four of the five best performing funds over the period sat in the sector.
The FTSE All Share sold off by around 10 per cent between March and June 2012, and once again, gilt funds rallied, on average by 7 per cent.
The graph below shows the performance of IMA UK All Companies funds and IMA UK Gilts funds since the beginning of 2007. The inverse performance of the two sectors is clear to see.
The green line represents a composite portfolio, split 60/40 between the two sectors.
The portfolio has returned slightly more than the average UK growth fund, with significantly less volatility and a 28.57 per cent max drawdown compared to 45.79 per cent.
Performance of sectors and composite portfolio since Jan 2007
Source: FE Analytics
Tilney Bestinvest’s Jason Hollands (pictured) says historically gilts have been ideal at offsetting equity risk, often protecting against the downside more effectively than more expensive absolute return vehicles.
However, he thinks the results are the perfect illustration of why past performance should not be used as a guide to the future.“It’s a very simple trade – traditionally when investors are bearish about equity markets, they go into government bonds,” he said.
“That could well happen again in the event of a major market correction, for example should the situations in Ukraine or the Middle East further escalate or if the global oil supply comes under threat.”
“However, one of the key risks to asset markets at the moment potentially comes from an overreaction to future monetary tightening. Under that scenario you could see a synchronised sell-off across both shares and bonds.”
The possibility of a double correction in equities and bonds was discussed in more by FE Alpha Manager Bill McQuaker in a recent FE Trustnet interview.
Both equities and gilts fell when the possibility of interest rate rises were discussed last summer, which could be seen as a forewarning for a greater correction in the coming months.
The All Share fell by just over 9 per cent over the period, which is why it wasn’t included in the initial study.
Performance of indices in 2013
Source: FE Analytics
Hollands says defined benefit pensions schemes will provide a backstop to rising bond yields as they are compelled to have a significant allocation to fixed interest, but still thinks it’s unlikely that they will perform strongly in an interest rate-led sell-off.
“With yields where they are and interest rates looking like they’ll rise, I would have to question investors aggressively allocating to gilts,” he said.
“They do tend to do well during sell-offs, but the same risks don’t apply here.”
Hollands says backward-looking model portfolios designed for cautious investors could come under huge pressure for this reason.
“As a general rule it’s good to have an allocation to quality bonds including gilts and corporates, but following a period of massive central bank easing, the compression in government bond yields will ultimately unwind,” he said.
Hargreaves Lansdown’s Richard Troue agrees. He thinks investors would be much better off holding dynamic multi-asset funds that can create a diversified portfolio of uncorrelated assets.
“The scope for significant gains in gilts is now very limited,” he said. “They might hold up better in a sell-off to some extent, but probably not by the margin they have in recent years.”
“I’d be more likely to go for a total return fund – one with a multi-asset focus, including some equity market exposure.”
“Something like Trojan has held up very well [during times of stress]. It invests in government bonds, cash and some blue chip equities which tend to outperform when markets fall. It also holds gold and some other commodities, which have the potentially to perform very differently to everything else.”
