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AJ Bell’s CIO: I’m begging you not to invest in government bonds

30 November 2018

Kevin Doran points out that every country with a debt-to-GDP ratio of above 80 per cent has defaulted – although not necessarily in an obvious way.

By Anthony Luzio,

Editor, FE Trustnet Magazine

AJ Bell’s Kevin Doran is “begging” financial advisers not to put cautious clients in government bonds, saying the UK and most other developed nations will “absolutely” default on their debt.

Post-RDR (Retail Distribution Review) there has been a surge in popularity of all-in-one risk-targeted portfolios, which aim to match clients with portfolios based largely on their tolerance of volatility.

Data from the latest Schroder Adviser Survey indicated that the proportion of IFAs outsourcing their client portfolio management grew from 45 per cent in 2014 to 58 per cent in 2017.

However, Doran – chief investment officer at AJ Bell – said while financial advisers are trying to do the right thing by outsourcing their investment decisions, the problem is these portfolios base their asset allocation on historical returns – meaning that the more cautious the investor, the higher their exposure to government bonds.

And this, according to Doran (pictured), is where the problems start.

“The UK government has a debt-to-GDP ratio of over 80 per cent,” he explained. “History tells us that any nation that gets a debt-to-GDP ratio of over 80 per cent defaults on its debt. And the UK will absolutely be on that list.”


While a government default calls to mind memories of Greece or Argentina telling their creditors they won’t get their money back, Doran said this is one of only three ways this process can happen – and the UK is likely to follow one of the two other “slightly more cunning” options.

“You can devalue your currency,” he added, “which is effectively a default on all of your foreign creditors.

“Alternatively, you can allow inflation, which is a default on your domestic creditors.”

Data from FE Analytics shows that £1 put in a savings account since the start of March 2009 would now be worth just £1.0474, but with inflation growing by 24.65 per cent over the same period, the original sum would have lost more than 23.5 per cent of its purchasing power.

Performance of indices since Mar 2009

Source: FE Analytics

Doran believes this will be the shape of things to come, pointing out the only way the UK can get its debt-to-GDP ratio down to a more manageable level is through rising nominal GDP, which only happens in one of three ways – increasing the number of people in the economy, increasing productivity, or increasing inflation.

“But we’re not getting better at doing things,” he continued. “You don’t make the productivity gains that you did 20, 30 or 40 years ago because we’ve moved from a manufacturing-based economy to a service-based economy.

“It’s very easy to create a machine that is twice as effective at making widgets, but it’s very hard to create a hairdresser that can do two heads at a time. So once we moved to a service-based economy, you lost the ability to make big productivity gains.

“And the last time I checked, we weren’t exactly welcoming people into the UK. That means inflation is the only way that the UK government can possibly pay off its debt.”

It is not just in the UK where investors are sceptical towards the prospects for government bonds. A graph of Berkshire Hathaway’s asset allocation going back to 1999 shows that the group’s exposure to US Treasuries has gone from a quarter of the portfolio down to 2 per cent, with this movement accelerating over the past few years.

Source: Berkshire Hathaway/AJ Bell

Russ Mould, investment director at AJ Bell, pointed out that Warren Buffett is a strictly bottom-up investor who focuses on company fundamentals.

“He doesn’t make macro calls by any stretch of the imagination,” said Mould. “But while he may not be making a call on inflation, he certainly seems to think bonds are not particularly attractively valued right now.”


Doran said he wanted to make an appeal to financial advisers to follow the example set by Buffett.

“UK government bonds, US government bonds, Japanese government bonds – all of these nations have a debt-to-GDP ratio above 80 per cent. And they are all going to default on it,” he said.

“Every single one of them. And the method they are going to use to default on you is not that you are not going to get your money back. You will get your money back.

“But it will be in a high inflation environment. It will be in falling currencies.”

Despite this knowledge, Doran said the industry continues to push cautious investors into government bonds and because of the desire to reduce costs, it is doing this via passive products.

“And I am begging you not to do it,” he continued. “Absolutely begging you not to do it. Because this is what the industry looks like from where I am sat: we are jumping off cliffs because everyone else is doing it. ‘If everyone else is doing it, why don’t we?’

“Well, we shouldn’t be doing it, because we know if we put all these pieces of the jigsaw together, we know in our heart of hearts that we don’t want to jump.”

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