There has been a frenzy of worry over the possibility of a significant correction in fixed interest, particularly in UK gilts, which could deal a particularly big blow to those approaching retirement.
However, Holman (pictured) says that not only are the concerns over a bond bubble overplayed – it’s actually impossible for there to be a bubble at all.
He points out that while equities can continue to rise well above their historic valuations, bonds don’t have the same characteristics. “I don’t think the word bubble should really apply to bonds,” he said.
“It’s very difficult to get a bubble going because we don’t have bonds trading at 150 per cent [of their value]. The whole concept of a bond bubble is not something put into the right context.”
“A bubble is something that starts as a fundamentally good idea or trade, so much so that many investors are lured in by the economic benefit.”
“Over time, as investor momentum builds, the trade changes from being cheap to expensive, then very expensive, until (and most crucially) the fundamentals supporting that trade disappear altogether, leaving the price prone to heavy and rapid deflation - the ‘bubble bursts’.”
“We don’t have that in bonds.”
Holman says that the historically low yields on bonds are fair, because the underlying economy is in such a desperate state.
“We should have higher yields, but that’s a long way away because the economy is really poor,” he said.
“We have ultra-low rates for a very good reason and beyond that we have extraordinary measures being deployed by governments and central banks in order to cure the economies of their past ills. We really do not see Europe’s or the UK’s economic woes being cured any time soon, so the case for low rates is still very much in place.”
He points out that the Bank of England is continuing to forecast doom and gloom for the UK economy, which he says is “not consistent with runaway bond yields.”
However, Holman says investors shouldn’t expect the kinds of returns from bonds that were seen in the past.
“Will you get hit by a burst bubble in gilts, no, I don’t think you will. But will you get decent returns from gilts, the answer is also no,” he said.
Performance of index and sector over 5yrs
Source: FE Analytics
Gilts have been one of the best performing asset classes of the last five years, outperforming the FTSE All Share with a fraction of the volatility.
Holman accepts yields are likely to rise on gilts before interest rates do, but doesn’t believe this warrants the term ‘bubble’.
“We appreciate that markets will likely start to re-price higher government bond yields in advance of any rate hike, and it is here that the term ‘bubble’ is targeted,” he said.
Holman highlights the ‘bond bubble burst’ of 1994 when the US Federal Reserve hiked interest rates unexpectedly and gilts lost 10 per cent.
However, he says this was merely a correction rather than a bubble bursting.
“This short six month period led to a ferocious selling of gilts as the market decided that the Bank of England was being lackadaisical towards inflation,” he explained. “Yes, the fundamental rationale for holding gilts had gone, but an 8 per cent total return loss was no bubble.”
Performance of sector and index 1993-1995
Source: FE Analytics
Holman adds that worries over rising gilt yields have come far too soon because the government’s long-term goal of getting financing low for everyone – from large corporations to small and medium companies – has not had time to take effect.
“Base rates in the UK have already been taken almost as low as they can go and this has not been enough to stimulate the economy, therefore the Bank of England has sought to bring down financing costs all along the yield curve by engaging in quantitative easing,” he said.
“We now have the lowest gilt yields in history, but clearly this is still not enough even though it has fed nicely into lower yields for both corporate bonds and high-yield bonds.”
While gilt yields can’t go any lower, Holman says there is still an opportunity for investors because credit spreads above gilt yields are too high – and will likely narrow.
“In the fixed income game now it’s about getting income or yield without taking too much interest rate risk. Take credit spread risk instead,” he said.
“Despite ultra-low government bonds yields, where the upside is now behind us, there is still a major theme to play out: the tightening of credit spreads, not just to the mean, but through the mean. This will remain a policy objective until we see a material improvement in the underlying economies.”
“It is clearly a government objective to bring these spreads down, so that finally we have low rates for everyone, thereby giving the economy the best possible monetary platform for growth,” he added.
Holman and his team head up the four crown-rated PFS TwentyFour Monument Bond fund. They also run the £112.3m PFS TwentyFour Dynamic Bond fund, but this doesn’t yet have a three year track record.
The Dynamic portfolio is yielding 7.08 per cent, well ahead of the majority of bond portfolios available to UK investors, while the more conservative Monument fund is yielding 3.14 per cent.
Both portfolios have outperformed the LIBOR GBP 3 month index significantly over one year, and the Monument fund has also beaten it over three years.
Over the last year, the Monument fund made 10.6 per cent while the Dynamic portfolio gained 12.28 per cent. The LIBOR index gained just 0.69 per cent over the period.
Performance of funds vs index over 1yr
Source: FE Analytics
The Monument fund is available for a minimum investment of £1,000 and has an ongoing charges fee (OCF) of 1.06 per cent.
The Dynamic portfolio has a minimum investment of £1,000 and an OCF of just 0.9 per cent.