The long-heralded bond bear market may have already been and gone, slipping under the radar of the pessimists that have been calling it for the best part of the last decade, according to Mark Benstead, head of active credit solutions at Legal & General Investment Management
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Government bonds have been among the best defensive assets to hold over the past 30 years, with the IA UK Gilts sector up by more than 400 per cent since the start of 1990 and the ICE BofAML US Treasury index returning a similar amount.
The performance of these assets has been driven by a drop in interest rates, but when these fell close to zero in the wake of the financial crisis, many commentators warned that the only way was up for bond yields – which would pull their price down.
More than 10 years after the financial crisis, “bond bears” claim that while a bubble in fixed income has yet to burst, it is still just a question of when and not if. However Benstead (pictured), who runs the £1.3bn L&G Fixed Interest Trust, takes a different view.
“Funnily enough, we may have had the bond bear market, it’s just nobody's really noticed it or flagged it,” he explained.
“If you go back to September 2016, post the referendum, 10-year gilt yields got to 51 basis points and 10-year Treasuries were around 135.
“Dial yourself back to October of last year, 10-year gilts were 170, so they more than tripled, and 10-year Treasuries were 3.25, so they more than doubled. So maybe, just maybe, we had the bond bear market and all the clever bond bears didn't notice it when they should have been out there shouting it from the rooftops.”
Source: LGIM
The manager said that it certainly felt like a bear market felt to him. Had he been allowed to, he said he would have put a sign over the door of his office advertising the sale of bottled water and guns, adding “we were unashamedly, you know, 'the world is going to end'”.
While Benstead has not had a “Damascene-like conversion”, he said that he underestimated the willingness and ability of central banks to keep the party going. He added that while the potential headwinds that made him so underweight risk for so long are structural rather than cyclical, he has begun to add risk across his portfolios, saying that we may not just be in a lower-for-longer environment, but a “lower forever” one.
“We christened it ‘secular strangulation’, rather than secular stagnation,” he continued. “It's not that yields can't go up. Of course they can. We just don't think they can go up very much given the absolute level of debt creation since the crisis and the burden of that repayment.
“Anything that vaguely normalises yields and increases the impact of that debt burden will hit consumption, which is still kind of 60 to 70 per cent of GDP, sends economies teetering towards the edge and forces central banks to turn the taps on again.
“So, can yields go up? Yes, definitely. Can they go up much? No.”
Despite the fact Benstead has increased risk exposure across his funds, he warned that fixed income investors should expect much lower returns in the coming years. For example, he recently had to cover a client meeting for a colleague and said he couldn’t help noticing the fund’s benchmark, the IBOXX UK Sterling Corporate 10 or More Year index, was up by 16 per cent to the end of October.
Performance of index year-to-date
Source: FE Analytics
The manager said this isn’t normal.
“You shouldn't be getting that out of fixed income, should you? You really shouldn't,” he added.
“I go on the road quite a lot and people say to me, ‘Mark, what might we expect from fixed income going forward?’, and without wanting to shock, I say, ‘well, should we start with the coupon?’ It sets people back in their seat.
“There was a big Sunday Times pull-out on corporate bonds two weeks ago and there was nothing that interesting in there apart from, in lights, the annualised total return from sterling corporate bonds this century: 6.1 per cent. And the FTSE 100 was at 5.1 per cent. It shouldn't be like that.
“Mathematically, it's very difficult to see how those returns can be generated in the future. But you know what? I think if we've learned anything over the last 10 years, there's no yield that can't halve.”
So why own bonds at all when they are unlikely to make much of a return and yields are so low? Benstead’s response to this question is “why indeed?”, adding he completely understands why people avoid the asset class if they think yields are going up.
However, he said that aside from income, bonds also provide diversification and protection – but warned that anyone chasing yield at all costs may end up forgoing the latter two attributes.
“Fixed income can only properly protect and diversify if you have enough duration to give you a sufficient capital gain when yields fall,” the manager said.
“If you have short duration – as a genuine alternative to cash, I get it. As a way of protecting and diversifying, I think it's awful. Because actually, a lot of those short duration funds are stuffed full of high yield, because otherwise, you know, you're getting one-and-a-bit per cent and you're paying 50 basis points for the privilege.
“In a risk-off scenario, it will behave much more akin to equities than it will to government bonds. It doesn't help you and it might actually genuinely hurt you.
“To me, the reason to buy bonds is unchanged. It's about protection and diversification. Would that be an easier conversation if yields were 100 basis points higher? Of course it would, but they're not.
“So, to answer your question, ‘why buy bonds now?’, it is for the same reason why you should have always bought them, but it's definitely harder.”
Performance of fund vs sector and index under manager tenure
Source: FE Analytics
Data from FE Analytics shows L&G Fixed Interest Trust has made 30.49 per cent since Benstead took charge in September 2014, compared with gains of 33.15 per cent from the iBoxx Sterling Corporate index and 25.63 per cent from its IA Sterling Corporate Bond sector.
It is yielding 2.5 per cent and has ongoing charges of 0.33 per cent.