Miton’s David Jane is moving away from yielding assets across his range of multi-asset funds, arguing that years of unprecedented monetary policy from the world’s central banks means that investors now have to pay more attention to the possible losses. 
Fixed income has been a primary beneficiary of quantitative easing (QE) programmes from the Federal Reserve and the Bank of England – and more recently the European Central Bank and the Bank of Japan – in the post-financial crisis world.
But the strong returns of bonds over this period, which have pushed yields in many parts of the market to historic lows, have caused some commentators to call the end of the multi-decade bull run in the asset class – especially as the Fed prepares to make its first interest rate hike.
Performance of index over 8yrs
Source: FE Analytics
Fragility has marked the bond market over 2015 so far with the asset class being hit with a sustained sell-off, especially in government debt. There’s a lack of consensus about what has been driving this, but issues such as a push-back against negative interest rates, a lack of liquidity, the prospect of rate rises and signs of strong economic growth have all been cited.
Jane, the co-manager of Miton’s multi asset fund range, believes that the days of universal falls in bond yields are now behind us and says fixed income investors have to be more cognisant of downside risk over looking for high returns.
He also thinks that investors should not necessarily confine their concerns to fixed income as QE has driven up the prices of other assets, including defensive ‘bond proxy’ equities and parts of the real estate market.
“The volatility at the end of January and beginning of February which led us to reconsider the merits of our long-dated bond positions has recently been repeated in Germany, and this has also coincided with a change of direction,” the manager said.
“It seems clear that the era of ever falling bond yields is now behind us and we are now at best in a sideways range and more likely in a rising trend. If this is the case we need to revise not only our view within fixed income but also need to consider whether some of the trends in other asset classes which have been driven by this powerful force are also set to reverse.”
Jane argues that the past few years have played out in the opposite way to what market theory would suggest. For example, credit spreads have been driven consistently lower as government yields have fallen thanks to the ongoing search for yields – which defies the “conventional wisdom” of an inverse relationship between spreads and yield.
And while market theory suggests falling bond yields benefit high growth stocks, the opposite has happened as investors flocked to ‘bond proxies’ with high current yields in a bid to gain income from dividends when cash deposits and government bonds pay out little.
Defensive vs cyclical industries over 8yrs
Source: FE Analytics
“Looking to the future, our basic thesis is that the risk in bond markets is to the downside,” Jane said.
“Yields can only fall so far from here and yet can rise materially, so even if we are wrong that the long-term trend is now higher, the downside is limited. This means that we must be ‘loss averse’ rather than ‘return seeking’ in our bond positions, as the risk is largely to the downside.”
“In equities the situation is more nuanced. The relative attractions of high yielding defensives are diminished versus mid and small-sized growth companies, now that income is less scarce and growth is stronger. At the same time it is difficult to make a negative absolute valuation case against high yielding equities, which have real dividend growth capability and yields of 4 per cent or more.”
“Unless of course we think that there is a high chance that bond yields are heading to the levels of a few years ago in the near term, a situation which would occur if nominal growth rates accelerate rapidly which would on balance be positive for equities.”
These concerns have led to changes in the manager’s range, which includes the CF Miton Cautious Multi Asset and CF Miton Defensive Multi Asset funds.
“We have been repositioning our portfolios over the course of the year away from yield in all its forms and towards what seems, counterintuitively, a lower risk position in fixed income and equities of short dated credit and mid-sized equities. In effect less exposed to a dominant macro theme and more exposed to a broader range of longer term investment themes such as our disruptive technology theme,” he explained.
