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Bond sell-off: The start of a bear market or just a blip?

15 May 2015

Following the global bond sell-off seen over the last few weeks, a panel of financial experts discuss what this means for the future of the debt market.

By Lauren Mason,

Reporter, FE Trustnet

The global bond sell-off that has stalked the markets over recent weeks has left some investors feeling more bearish than ever about the outlook for fixed income.

The prices of bonds in developed markets across the world plummeted in May, hitting German bunds in particular and sending yields rocketing.

Rowan Dartington Signature’s Guy Stephens says a loss for bonds is now “a mathematical certainty” given the stretched valuations being seen in many parts of the market, while M&G’s Anthony Doyle argues that the risk of losing money from even government bonds “has never been greater”.

Performance of index over 1 month

 

Source: FE Analytics

Ten-year government yields in the US, Germany and the UK have all increased by around 70 basis points since the start of the year, according to data from Capital Economics, although the reasoning behind this has puzzled many financial professionals.

Some analysts have suggested that illiquidity in the market, higher expectations of inflation and concerns that the European Central Bank will stop buying bonds sooner than expected could all be contributing factors.

So the mystery behind the sell-offs is not exactly instilling much faith in the bond market at the moment. Could this be the start of a bear market for bonds or is it just a temporary blip?

David Absolon, investment director at Heartwood Investment Management, said: “In our view, the factors contributing to the bond rout are two-fold. One: investors are reassessing the deflation tone and seeing some reflation (albeit moderate), which is leading to two: the unwinding of highly correlated trades, held by investors over the past year.”

“Indeed, over the past 12 months, the disinflationary backdrop led investors to implement ‘curve flattening’ trades by holding overweight exposure to long-duration assets. However, at the same time, investors were sanguine in their view that inflation was not going to destroy earnings multiples and so they stayed long on equities. Some of those views are now being reassessed and investors are consequently repositioning.”

Absolon also believes that liquidity constraints have magnified the price moves due to the high correlation between bond and equity market performance. However, he adds that this correlation is now starting to trend lower rather than higher.

“We expect the recent market volatility is a result of repositioning rather than anything more sinister,” he said.

“Reassuringly, higher yielding credit markets have been relatively stable. We should also remember that the eurozone has a large buyer on the side in the form of the European Central Bank.”

Macroeconomic forecasting consultancy Capital Economics also cautions investors about overplaying the significance of the recent sell-off.

“We can all be caught up in the mood of the moment, but talk of a ‘rout’ in global bond markets is, at best, premature,” chief global economist Julian Jessop stated.   

“Yields are still remarkably low by past standards. While they may rise further, notably in the US, this should generally be in tandem with renewed economic strength.”

“Central banks – notably the US Fed – are also likely to tread very carefully to prevent a more damaging sell-off. Nonetheless, the recovery in the eurozone does look more vulnerable than most, if recent market trends were to continue.”

Jessop urges investors to take a step back in order to realise what he says is the insignificance of the situation. 

According to the firm, long-term bond yields are still very low at around 2.2 per cent in the US, 1.9 per cent in the UK and 0.6 per cent in Germany – even after the rise in yields seen over the past few weeks.

Government bond yields over 10yrs

 
Source: Bloomberg / Capital Economics

 “The recent surge is the biggest since the Fed ‘taper tantrum’ in 2013. But the 2013 surge was much larger (and in Germany, from a much higher starting point), and it was also ultimately reversed,” Jessop continued.

 “What’s more, bond yields are only a little higher than they were at the start of the year in the US, UK, Germany, Spain and Japan, and actually still a little lower in Italy and Portugal.”

 Erring on the side of caution, however, JP Morgan Asset Management’s Nick Gartside believes it’s still too early to tell where the bond market will go from here. 

As such, the fund manager suggests that, within fixed income markets, it is safest to focus on funds that invest globally for as much diversification as possible. 

He said: “Investors need to have enough credit spread exposure to absorb rate moves higher and benefit from improving economic fundamentals, combined with some high quality ‘duration’ to provide ballast in periods of crisis, down-turns or re-emerging perceptions of deflation.”

Martin Bamford (pictured), chartered financial planner and managing director at Informed Choice, agrees that well-diversified defensive funds that are the best way to invest in the bond market at the moment.

As such, he would recommend the Henderson Strategic Bond fund, managed by FE Alpha Manager John Patullo since its launch in 1999 and co-managed by Jenna Barnard since 2006.

“In terms of a defensive bond fund, Henderson Strategic Bond is a good fund to consider,” Bamford said.

“The fund aims to provide a return by investing in higher yielding assets including high-yield bonds, investment grade bonds, government bonds, preference shares and other bonds.”

 “The managers can make strategic asset allocation decisions between countries, asset classes, sectors and credit ratings, which allows them to be defensive when market conditions suggest this is appropriate.”

 The fund has delivered 28.93 per cent over the past three years and 39.02 per cent over five years, comfortably exceeding the sector average.

Performance of fund vs sector over 3yrs

 

Source: FE Analytics

Henderson Strategic Bond has a clean ongoing charges figure of 0.7 per cent and yields 4.9 per cent. 

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