However, this has all changed as a result of ultra-low interest rates, quantitative easing (QE) and the ongoing hunt for income, which has pushed down bond yields and forced up valuations to levels where some are worried about a potential bubble.
As the graph below shows, gilts have outperformed the FTSE All Share in total return terms over the past market cycle.
Performance of indices over 8yrs
Source: FE Analytics
Many investors have become bearish on bonds over recent months, and it’s not difficult to see why. With some now offering negative yields, it seems that some people are willing to pay governments to lend them money.
A Sarasin & Partners ‘Market Focus’ report released yesterday predicted that a dwindling number of liquid government bonds in the eurozone is likely to push bond prices up to even more unattractive levels.
It seems that some bonds have become expensive assets that do nothing but leave investors out of pocket. However, Miton’s David Jane believes that there is more to the asset class than meets the eye.
“Equities are equities – they’re shares in companies, and to some degree they all have the same characteristics,” he said. “All equity markets are correlated with other equity markets and they’re all dependent on profits. They are correlated assets.”
“Bonds aren’t like that. They all have the characteristic that they’re lending to somebody rather than owning something, but actually they can be anything from lending money to the government on a one-week view, right through to lending money to Zimbabwe for 40 years, which has very different characteristics.”
Jane’s CF Miton Strategic Portfolio fund, renamed this week as CF Miton Defensive Multi Asset fund, holds 15.7 per cent UK corporate bonds, 14.9 per cent UK government bonds and 13.7 per cent overseas government bonds.
He highlights the vast range of investments this spread really represents.
“Saying you’ve got a lot of bonds doesn’t really tell anyone anything,” Jane explained.
“Whereas, if you look at a portfolio and say ‘it’s got x per cent in equities’, you know a lot about the portfolio. Whether it’s emerging markets or UK defensive companies, at the end of the day it’s equity and it’s going to correlate with equity.”
“You can have 50 per cent in bonds and which is effectively cash or you could have 50 per cent in bonds which is lent to distressed companies over long periods of time and have largely similar characteristics to equity.”
Despite the historically low interest rates, the introduction of QE in Europe, Japan and America reassures some investors that government bonds can still be a safe investment.
Jane said: “Some people don’t want bonds because there’s a lot of debt around and therefore, because countries have borrowed a lot of money, their chances of defaulting could be greater. However, mainstream countries, when they default, don’t typically default in the sense of ‘you’re not getting your money back’.”
“For instance, the UK Government can lend and borrow as many pounds as they like from whoever they see fit, and they can give them those pounds back. It doesn’t matter because we can make as many pounds as we like and so we are not going to default this early on to our sterling creditors.”
“So how does that risk really embody itself? It embodies itself in those pounds being worth less to the end owner of those bonds than he thought they were worth.”
Despite this, there are growing concerns that we are trapped in a bond bubble, which would mean that bonds as assets are over-priced. If we enter a period of inflation, investors could lose significant value.
However, many investors point out that fixed income is needed for a diversified portfolio, despite their expense.
Nick Hayes, manager of the AXA WF Global Strategic Bonds fund, believes that the asset class cannot be ignored and that investors should consider “yield give-up” as opposed to “yield pick-up”.
“Global fixed income is such a diverse asset class that you can’t just say ‘bonds are in a bubble’ and ignore the asset class,” he said. “We look at interest rate and credit-sensitive bonds, long and short maturity, conventional and index-linked assets, let alone geographic diversification.”
“With yields at such low extremes we definitely prefer bonds of shorter maturity and continue to avoid long-dated government bond assets that have rallied so aggressively in recent months.”
“In addition we like credit, specifically US high yield, but when the overall reference valuation point for all fixed income is ‘expensive’, I believe that it’s fair to assume a re-pricing of US treasuries, and other core government bonds, could lead to a sell-off in most of the asset class.”
However, Hayes is concerned about the willingness of investors to embrace negative yields, labelling the current bond investment trend as a “capitulation” phase.
“We are certainly seeing some pretty extraordinary events that make us question what’s going on,” he added.
But amidst confusion and anxiety towards the asset class, even bond bears such as JP Morgan’s Bill Eigen are still finding some pockets of value in the market.
In January, the manager of the JPM Investments Income Opportunity fund told FE Trustnet that volatility became exploitable following the rapid decline in oil price at the end of last year.
Eigen bought bonds in the battered energy and emerging market debt sectors. This reduced his cash position, which had peaked at around 70 per cent, to about 45 per cent.
“If you make something cheap enough for us and the price doesn’t make sense, we’ll bring it in. That’s exactly what we did in December,” the manager said.