In a week where we have a Fed decision on interest rates it is worth reviewing our position on fixed income. 
We are firmly in the lower for longer camp, believing that in an era of low growth of the workforce, widespread deflationary forces and a huge government debt overhang, interest rates are likely to remain low for an extended period of time.
That does not mean, however, that they will never again rise.
This week the Fed may or may not raise rates but at some point in the next six months, apart from an unexpected economic development, they are bound to. The same goes for the UK. Europe and even Japan will eventually follow. At some point central banks may even start to sell their bond holdings.
What does this mean for bond markets?
Performance of indices in 2015
Source: FE Analytics
Our central case is that while policy rates may start to rise they will peak at lower levels than previous cycles because of the much lower structural growth rates.
Bond markets imply slightly higher short term rates in the future than we would expect. So you might say we should be bullish on bonds, particularly longer dated bonds, as we have been in the past. This ignores one critical factor in our investment process, we care not only about the strength of our view but also the risk and reward characteristics of each position and our overall portfolio.
If we are right and short term interest rates peak between 1 per cent and 1.5 per cent in this cycle it is reasonable to believe that 10 year bond yields can fall further, even to below the levels of six months ago, perhaps to as low as 1 per cent or 1.3 per cent.
How much could we make in this scenario, potentially as much as 9 per cent at a yield of 1 per cent on the ten year gilt.
However, if we were wrong and our lower for longer thesis is incorrect the downside is unbounded, but realistically long term rates could revert to levels that prevailed pre financial crisis or worse in an inflationary scenario, leading to losses of 20 per cent at a yield of 4 per cent.
Therefore, if we stick to the short end of the yield curve we can expect to earn 0.7 per cent, which together with another 1 per cent of spread by investing in corporate bonds would generate a 1.7 per cent return.
We are foregoing the opportunity to make up to 9 per cent but are avoiding the risk of a material loss in the alternate scenario. At the same time we can benefit from our lower for longer thesis in our positions in REITS whilst getting some downside protection in the inflationary scenario of rising bond yields from higher rental growth expectations.
In summary, sometimes the strength of your view needs to be tempered by a clear understanding of the risk reward characteristics of an investment decision.
We have many places where we can invest for attractive returns, but sometimes standing aside and missing an opportunity is a better option than taking it and exposing the fund to the risk of huge losses.
David Jane is manager of Miton’s multi asset fund range, having moved to the group in June last year. He currently manages the CF Miton Defensive Multi Asset, CF Miton Total Return, CF Miton Cautious Multi Asset and PFS Darwin Multi Asset funds.
Prior to taking up his post at Miton, Jane ran his own boutique (Miton) and was formerly head of equities at M&G.
Performance of manager versus peer group composite during career
Source: FE Analytics
He has been running funds in the Investment Association since July 2002 over which time he has returned 128.33 per cent to his investors, beating his peer group composite by close to 20 percentage points in the process.
