The “insanity” that has gripped fixed income markets has only increased over recent months, according to William Littlewood at Artemis, who is still 99 per cent net short government bonds within his Strategic Assets fund. 
Yields on developed market government bonds have once again taken a nose dive in 2016 as equity market volatility has ramped up, macroeconomic uncertainty has heightened and central banks around the world have pursued evermore extraordinary monetary policies.
These include an even greater quantitative easing package from the ECB, the US Federal Reserve’s decision to revise down its interest rate hike expectations and the Bank of Japan’s surprise move to implement negative interest rates.
This has led to some impressive gains from traditional ‘safe haven’ government bonds, with the likes of FTSE Actuaries UK Conventional Gilts All Stocks, The BofA ML US Treasury and The BofA ML Euro Government indices up 5.3 per cent on average in 2016, while the Citi Japanese Government Bond index has made a hefty 14.91 per cent over that time.
Performance of indices in 2016
Source: FE Analytics
It means that 10 year gilts now yield 1.62 per cent, 10 year US treasuries yield 1.9 per cent and 10 year German bunds yield just 0.25 per cent. On top of that, 10 year Japanese government bonds now have a negative 0.11 per cent yield.
Again, as has so often been the case over recent years, this performance has come as a surprise to many as the large majority of fund managers went into the year believing sovereign debt was wildly overvalued and not reflective of underlying economic fundamentals.
Littlewood, who has been net short government bonds within his £816m Artemis Strategic Assets for a number of years, is one such manager due to his concerns about central bank-induced distortions within the market and the very low yields on offer.
In his most recent note to investors, he explained that he has taken some profits from the recent snap rally in equities but has only increased his short bond exposure due to his belief that the fixed income market is now completely broken.
“Meanwhile, the insanity gripping bond markets persisted,” Littlewood (pictured) said.
“Japan was able to issue a 30-year bond at a yield of just 0.47 per cent, an all-time record low. If Japan’s finances seem troubled now, think of what the position might look like in 30 years’ time when its population is expected to have declined by 30 per cent and its population of working age by 33 per cent.”
He added: “The country will have more people retired than working. In our view, to overlook this, the holder of a bond yielding 0.47 per cent must be irrational, myopic or a government.”
Investors in Littlewood’s fund will have no doubt heard similar rhetoric from the manager in the past – indeed he is one of the few available to retail investors who will seemingly make money from a bond market crash given his extensive use of shorts within his portfolio.
However, this long held view has been detrimental to his relative returns.
According to FE Analytics, for example, Artemis Strategic Assets has underperformed its IA Flexible Investment Sector average since launch in May 2009 with returns of 67.34 per cent.
Performance of fund versus sector index since launch
Source: FE Analytics
That being said, for those who have wanted to hedge against potential bond market risk, Artemis Strategic Assets has arguably been a good option given it has had a negative 0.4 correlation to the likes of gilts since inception – with the fund outperforming its peers during periods of rising fixed income yields.
These include the likes of May 2013, when yields spiked dramatically following comments from the US Federal Reserve that suggesting the central banks were planning to reverse their ultra-loose monetary policy.
Performance of fund versus sector and index in 2013
Source: FE Analytics
Still though, there are those who question the need to have such extreme fixed income positioning within a multi asset portfolio.
Indeed, some hold the view that in the face of a ‘lower for longer’ environment, a lack of inflationary impulses and an ageing population, the chances of a significant bond market crash are very low. Advocates of this view also add that even if yields were to spike, it would be a temporary phenomenon given the lack of income on offer in financial markets.
However (and although he mainly focuses on equities), Aberdeen’s Bruce Stout also believes that the extraordinary monetary policies of central banks have only distorted markets and set investors up for a very painful period at some point in the not so distant future.
He has held this view for a while and reiterated his thoughts in his most recent note to shareholders of his Murray International Trust.
“Having consistently papered over the cracks of structural economic vulnerability for the past decade, Central Bank policymakers are well versed in responding to financial market insecurities despite their deepening impotency to act constructively,” Stout said.
“How long this veneer of respectability will endure is open to debate, but should at some point the mask slip and all credibility be lost, then no-one should arguably be surprised. Against such a distorted and dysfunctional economic backdrop the emphasis remains on portfolio diversification in pursuit of capital preservation.”
However, Stout’s bearish view on global markets – and preference for developing world assets – has meant his popular trust has also struggled recently.
In total return terms, the trust has fallen some 6 per cent over three years compared to a 22.15 per cent rise in its composite benchmark and a 17.59 per cent gain from its average peer in the IT Global Equity Income sector.
Performance of trust versus sector and benchmark over 3yrs
Source: FE Analytics
Though its NAV returns have been poor, most of those losses have been fuelled by a falling premium. It currently trades around NAV, though its shares have been on an average 7 per cent premium over the past three years.
Nevertheless, it is still one of the sector’s best performers over the longer term and now yields 4.78 per cent due to its poor share price returns.