Extraordinarily low bond yields will remain for some time to come, according to FE Alpha Manager ‘hall of famer’ Ian Spreadbury, who argues that much of the market continue to be expensive unless there is a seismic shift in the underlying economic fundamentals. 
Spreadbury, who heads up the £3.6bn Fidelity MoneyBuilder Income and £1.7bn Fidelity Strategic Bond funds, has long argued against the view that bonds are in a bubble as he has very much positioned for a low interest rate environment.
Indeed, the star manager’s base case has been for slow growth, low inflation and high systemic risk due to high levels of debt to GDP, an ageing population and over-capacity in the global economy.
However, Spreadbury admits that even he has been surprised by the significant rally in fixed income so far in 2016, with the ‘safest’ core government bonds leading the bull run. At the time of writing, a 10-year UK gilt yields less than 0.7 per cent – its lowest ever level.
10-year UK gilt yields in 2016
Source: FE Analytics
The manager, who is renowned for his cautious approach to fixed income, says there have been numerous reasons behind this trend.
“It’s been a dramatic fall in yields so far this year and I think it has caught a lot of people by surprise, myself included,” Spreadbury (pictured) said.
“We now have some 50 per cent of the sovereign bond market on negative yields. We’ve had some pretty dramatic moves in individual bonds, like a Spanish long-dated bond issued about three months ago which is now 20 per cent up.”
“The key factors are, firstly, slowing global growth and secondly, aggressive central bank action particularly in Japan and Europe.”
Spreadbury: “That is massive demand coming into the market.”
However, the manager adds that the major driver – certainly related to gilt yields – has been the impact of Brexit. Not only has there been a flight to safety among investors, but an expected cut from the Bank of England to help cope with the potential economic fallout has sent prices even higher.
Due to all these factors, Spreadbury cannot see a scenario whereby government bond yields spike from here.
“In anticipation of lower growth in the UK, yields have come down with the 10-year yield down to about 70 basis points. These are all time lows, incredible levels really. We will have to wait and see, but it feels very much like these low yields will continue.”
Spreadbury’s thoughts are echoed by fellow strategic bond manager John Pattullo, who told FE Trustnet recently that he was focusing on long duration assets as inflation is non-existent, economic growth is poor and there is still a high level of debt in the system.
“There are lots of people who think interest rates are going up and inflation is coming back. If you have read any of the stuff we have written over the past five years, you’ll know we think the complete opposite,” Pattullo said.
“We think bond yields will continue to fall. We think inflation is not a threat at all. We think you want to lock-in good coupon yields.”
Nevertheless, given bond yields are now at historic lows and the 10-year gilt yield has come down by a hefty 78.82 per cent over the past seven years, many do feel fixed income in general massively overvalued and disconnected from economic reality.
10-year UK gilt yields over 7yrs
Source: FE Analytics
Certainly, current valuations suggest a very dire outlook for the global economy for a prolonged period of time as it points to a deflationary world where interest rates will seemingly never rise.
While Spreadbury admits they may look overvalued, that doesn’t mean there is a catalyst for a bond market collapse – which some have been anticipating for a very long time – on the horizon.
“I think they do [look expensive] a bit. Looking at historical data, gilts have on average been half to three quarters of a per cent less than nominal growth. So these yields seem to be indicating pretty low levels of nominal growth.”
“Again though, I think we need to wait and see on that. However, there are technical factors here such as a shortage of safe haven bonds – and gilts would fall into that category.”
“With the slowdown in the economy and increase in volatility, that shortage of safe-haven bonds like gilts and treasuries is becoming more acute and that has contributed to this fall in yields. That could remain for some time, actually.”
Indeed, the manager argues that yields could well go negative in the UK – depending on the future of the Bank of England’s monetary policy.
“The Bank of England has signalled its willingness to ease and so it is highly likely that they will cut rates at the next meeting, possibly by 25 basis points.”
“Can they go negative? I think it is entirely possible. My own view, though, is that there is a real question whether negative rates are actually working. There is a real concern that as rates come down, that people say ‘look rates are lower than they have been, the outlook for rates is that they will continue to be at very low levels, I need to save more’.”
Spreadbury has running fixed income fund since 1995. According to FE data, he has returned 193.51 per cent to his investors since the turn of the century, outperforming his peer group composite by some 50 percentage points in the process.
Performance of Spreadbury versus peers since January 2000
Source: FE Analytics
His relative outperformance has come from his ability to protect capital.
Indeed, not only is his Fidelity Strategic Bond fund the best performer in the IA Sterling Strategic Bond sector over 10 years from a total return point of view, it is also top decile for its maximum drawdown, annualised volatility and risk-adjusted returns (as measured by its Sharpe ratio) over that time.
