However, 10-year gilts currently yield 1.82 per cent, having started the year at around 3 per cent, with geo-political risk, equity market concerns, slowing growth in the eurozone and the possibility they were oversold last year all causing prices to rise.
It means that, according to FE Analytics, the Barclays Sterling Gilts index and the average fund in the IMA UK Gilts sector are both up 14 per cent this year, compared to a 2.46 per cent fall from the FTSE All Share.
Performance of sector vs indices in 2014
Source: FE Analytics
However, can investors expect more of the same in 2015 or, with the possibility of interest rates going up in both the US and the UK, is a correction on the horizon?
The current valuation on government bonds caused Bill Eigen, manager of the $8.5bn JPM Income Opportunity fund, to say that when the US Federal Reserve push up rates next year, it will cause “devastation” as the sovereign debt market simply isn’t priced correctly at the moment.
That being said, a recent FE Trustnet poll revealed very few investors agree with Eigen. When asked whether they expected an out-an-out crash in bonds next, 70 per cent of the 1,418 who voted said ‘no’.
Given that most investors hold fixed income in their portfolios for protection, as valuations are near the top end of their range and as the Fed has already stated its intention to raise rates sooner rather than later, we ask a number of our regular contacts whether investors are correct in their view or whether they are being overly complacent.
Neil Shillito, director at SG Wealth Management
“I’ve just finished writing my manager report for our multi-manager funds and in it I wrote that at the beginning of the year I was asked by one of our clients where I thought the FTSE would be by January 2015.”
“I hate answering those sorts of questions because in all honesty, I haven’t got a clue. I thought it would be a good year and so I went for 7,200 and it is currently 6,300, so I was just the 900 points off.”
“The question of gilts is similar because how many false dawns have we had with sovereign debt yields? Rising interest rates were supposed to make capital values drop, but rates have gone nowhere and people keep buying gilts and treasuries.”
“Russia is potentially dangerous because if they start defaulting on their loans it would cause contagion, but I have to say I have to agree with the 70 per cent because I don’t see a blood bath situation.”
“It’s not good for markets for that to happen and though [Fed chair] Janet Yellen has signalled she wants to raise rates, it’s only going to be by 25 basis points so you do wonder how much of an impact that will have.”
“So I don’t think bonds are going to crash, not next year anyway.”
Paul Warner, managing director at Minerva Fund Management and AFI panel member
“My view is that we will get a correction in the bond market, but whether that will be at the back end of next year or in 2016, I don’t know. These things always take longer than people think and it could well be the case that we get a short-term correction then people think ‘this is it’ and they come back again.”
“At some stage next year, however, we will see something that has never happened before and that is that a central bank pumping in liquidity at a time when economic growth is coming through and that will be the ECB.”
“QE has always started at times of stress, but I think that because of the oil price, the European economy will do quite well and that will induce fears of inflation.”
“I had a conversation with Bill Mott at the start of the year on the topic of inflation, and he said inflation will be clutched from the jaws of deflation. The ECB could well be injecting liquidity into an economy which is growing, and the oil price exacerbates that.”
“The bond vigilantes might well take advantage of that, but because there is so much demand for fixed income, I can’t work out whether the correction will happen next year or the year after.”
Gavin Haynes, managing director at Whitechurch Securities
“It comes down to the risk-reward. Our central view is that if interest rates were to rise at the back end of next year, it would be cursory due to headwinds such as the fragile UK economy and as inflation is back down to 1 per cent.”
“We don’t think, on that basis, that bond yields will increase significantly next year. However, there is so much uncertainty. Over the next three years, at some point, gilts are going to have a very difficult time.”
“With yields at 1.8 per cent, we just don’t think the risks are justified. Interest rates will start to rise but whether this becomes a problem in 2015, 2016 or 2017, who knows? Gilts have surprised everyone this year but just because they have done well, we are not going to change our view and we will remain underweight bonds.”
“I don’t think a 25 basis point hike in interest rates will have too much of an impact, but if inflation does come through or economic growth becomes more sustainable with lower oil prices, it will be the more meaningful rises down the line which is where the risks lie.”
“The problem is these things can move quickly so we don’t want to try and time the market and will keep our underweight position.”
