Government bonds can still offer protection to risk-on assets despite the rising correlation seen over the last few years, according to Quilter Cheviot model portfolio manager Simon Doherty.
Gilts have performed strongly more recently as ultra-low interest rates coupled with an uncertain macroeconomic environment have pushed bond yields ever lower.
Peaking last year, government bonds slipped back from their summer highs but year-to-date are on the way back, up 5.13 per cent since its year-low at the end of January.
Performance of gilts over 5yrs
Source: FE Analytics
Yet, despite the strong performance, Doherty said he still has “quite material exposure” to conventional gilts.
“We have a – broadly-speaking – risk-on tilt within the portfolios and that has been working well but our exposure to conventionals, I think, was a benefit – certainly last year,” he said.
“We’ve also had exposure to index-linked gilts in recent times although we actually exited our exposure to linkers in mid-March.
“It is an allocation that served us very well in 2016 with the returns that we saw there and our preference still is for sovereign debts at the moment over investment grade.”
However, he said this is not – by any stretch of the imagination – a result of the manager being exceptionally bullish on government bonds in the long term.
“That is not as a result of us feeling that there is still tremendous returns to go in that space but I think it is beneficial in terms of balancing risk in the portfolio,” he said.
Indeed, he maintains underweight positions in the fixed income sector in general as his portfolios have taken a more equity-focused tilt.
He explained “We are still tactically underweight the asset class and I don’t think we are alone – a lot of people are – but we see a difference between being tactically underweight and materially betting that this is the end of the great bond bull market.
“Our view is not that we are going to see a huge compression in bond yields from here but again in terms of your overall portfolio management and risk management what we don’t see is a drastic spike in bond yields from here either.
“We still see merit in having an allocation to the asset class albeit in preference of equities over gilts. We still like risk assets over bonds.”
He said at both a sector level and at a risk level, it is prudent to hold government bonds to add protection to the portfolios.
“We hold the conventional gilt exposure to offset what is still a risk-on tilt in our overall equity allocations and the adjacent absolute return and cash positions that we have too,” the manager said.
Within the fixed interest space he owned a pure index-linked tracker fund, though he sold out of this exposure in mid-March.
“That is a fund that we have sold – so it’s not all been one way traffic in terms of being in index funds,” he said.
Instead he has moved allocation to the more conventional gilt space, where he has chosen to invest in Mike Riddell’s Allianz Gilt Yield.
The £1.2bn fund has been a top quartile performer over the last year, returning 7.82 per cent, and also has a strong long-term track record, up 85.52 per cent over the last decade.
Performance of fund vs sector and benchmark over 1yr
Source: FE Analytics
“We feel very comfortable having an active manager in the gilt space at the current time given what is quite a fast-changing environment to that asset class,” Doherty said.
The fund, which has a clean ongoing charges figure of 0.53 per cent is currently yielding 1.35 per cent and has the majority of its exposure in the long-dated government bonds. 
It has 37.1 per cent of its exposure in bonds dated between 10 and 20 years and 24.7 per cent in bonds with a life of more than 20 years.
In its latest research note, Square Mile Research said: “This fund gives exposure to UK government bonds (gilts) in a riskcontrolled manner.
“Riddell (pictured) has many years of experience in managing bond funds for some of the UK's biggest asset management houses. However, he has little experience of managing pure UK government bond mandates.
“For this reason we have awarded the fund a Positive Prospect rating, reflecting our appreciation of Riddell's careful and considered approach, his knowledge of bond markets and wider macroeconomic forces, and the support of the experienced Allianz team, whilst acknowledging his lack of relevant track record in this specific part of the asset class.”
Riddell took over the fund at the end of 2015 having previously managed a number of funds during his time at M&G including the emerging market bond, index0linked bonds and global government bond funds.
“This is a relatively efficient market, making it difficult to produce returns in excess of the benchmark. Once fees have been deducted, any outperformance is likely to be slim,” Square Mile said.
“However, we feel that the considered approach which the manager employs is likely to be of benefit to investors at certain times of the economic cycle, for example during periods of prolonged rising yields.
“At such times an active manager should have an advantage over a passive investor through his ability to manage broad risks, such as interest rate risk, to the benefit of the end investor.
“This fund is likely to be suitable for investors looking for a level of income largely in line with that on the UK government bond market, and the diversification which exposure to this asset class brings to a balanced portfolio.”