Investors should have been bullish on fixed income over the last few years despite concerns surrounding interest rate hikes, higher levels of inflation and the potential end of a 30-year bond bull market, according to Mark Dampier.
The research director at Hargreaves Lansdown says that fears surrounding the impending EU referendum has sparked the recent rally in fixed income markets, with most of the sterling-denominated sectors outperforming the FTSE All Share index over the last three months.
Performance of sectors vs index over 3months
Source: FE Analytics
According to the latest data from the Investment Association, fixed income funds proved to be the most popular asset class in April, having seen net retail sales of £679m over that month alone. This is more than double the sales of the second best-selling asset class – mixed asset funds – which saw sales of £242m.
This data severely contrasts with FE Trustnet’s survey that was also conducted in April, which found that 70 per cent of readers were underweight fixed income in their portfolios and more than two-thirds believed there was at least a 50/50 possibly of a bond bear market rearing its head.
Many investors have been negative on the asset class over recent years, due to unusual monetary policy elongating the market cycle and pushing fixed income prices high and their yields lower. 
Dampier (pictured), however, believes that this sentiment has led to a vast number of people missing out on potential income, returns and portfolio diversification.
“We might have a bond bear market eventually, but investors have all been wrong. That’s my point, [FE Trustnet] could have sent that survey round three years ago and it would have had the same response,” he said.
“They’ve all been wrong. I think I would actually be more worried if the results were the other way around. Given that consensus regarding a bond bear market, I would suggest that the bond bull market will continue for longer yet.”
In an article published last year, Fidelity’s Eugene Philalithis told FE Trustnet that traditional income-producing assets such as government bonds and investment-grade corporates should no longer be appealing to investors, given the uncertainty of the macro outlook.
Dampier agrees that the current environment has been particularly gruelling for income investors and that the sheer length of the bond bull market is likely to cause doubts surrounding the asset class, but points out that interest rates are highly unlikely to rise rapidly over the medium term.
“We’ve been more bullish on fixed interest than most over the years. I thought the idea of a bond bubble three years ago was mad and I’ve continued to think that,” Dampier said.
“As time progresses you start to become more nervous of that, but then you’ve got to think that even if interest rates rise, how far are they going to go?”
“If you’d asked me three years ago I would have said I could never see them reaching more than 2 per cent in the UK and I still can’t see more than that now. I can’t see that for quite some time, either. I’ve got no idea when the first one will be but I don’t see any of the economies being so strong that they’re going to go up significantly.”
“Inflation might tick up a bit with the oil price moving upwards but you have to remember that we had inflation at 5 per cent at one point and the Bank of England didn’t move interest rates.”
In terms of fixed income assets being branded as expensive by some investors, the research director argues that only government bonds appear to have become markedly more expensive.
With corporate debt, he says that it isn’t necessarily more expensive against default rates and points out that, despite widespread panic, defaults aren’t dramatically rising.
This, combined with the fact that economies globally are “ticking over”, means that the current environment is more attractive in terms of buying into corporate bonds than people realise.
“Economies aren’t going into full overload but nor are they falling into a recession, we’re kind of in this long middle period of GDP rates below what we would normally expect,” Dampier explained.
“That actually favours corporate debt in a way because, if you don’t see big booms and busts then credit stays fairly stable and, in the meantime, you’re getting paid over 4 per cent as well which really isn’t bad.”
One fixed income fund that the head of research particularly likes is Royal London Sterling Extra Yield Bond, which is £1.2bn size and has four FE crowns.
It has been headed up by Eric Holt since 2003 and, over this time frame, it has provided a total return of 155.12 per cent, which is broadly in line with its FTSE Actuaries UK Conventional Gilts Over 15 Years index and is a 70.36 percentage point outperformance versus its sector average.
Performance of fund vs sector and benchmark under Holt
Source: FE Analytics
“While it’s not been that exciting in terms of capital, it has a yield of 7.2 per cent and if you stick that in an ISA or SIPP then that’s not a bad return given it’s stable and it’s tax-free,” Dampier said.
Aside from vehicles that focus on high yield and ungraded bonds, the head of research also likes FE Alpha Manager Ariel Bezalel’s Jupiter Strategic Bond fund, Alex Ralph and James Foster’s Artemis Strategic Bond fund and, in the IA Sterling Corporate Bond sector, Paul Causer, Paul Read and FE Alpha Manager Michael Matthews’ Invesco Perpetual Corporate Bond fund.
Because of the relatively unchanged macroeconomic environment, Dampier says that corporate bond funds have done particularly well over the years – despite the fact that most investors have expected a downturn and the end of the bond bull market.
Performance of sectors over 5yrs
Source: FE Analytics
“Most people have got fixed income entirely wrong, as far as I can see. They’ve all shouted ‘bubble’ over four or five years without seeing what the Fed and the central banks were doing, so it was far too early to be negative on fixed interest and, actually, corporate bonds in particular didn’t look bad value,” he said.
“They don’t necessarily look bad value today and obviously give you quite a large percentage of income given where interest rates are. So I suppose it’s not that much of a shock to see that fixed interest has gained popularity recently.”
