The bull market in government bonds has effectively been going on for 18 years, and long-dated issues have been producing negative real returns for a couple of these. So fears of a correction are inevitable.
Bond fund managers acknowledge that it is hard to achieve attractive returns when 10-year US treasury notes are yielding 1.8 per cent, 10-year German bunds 1.5 per cent and 10-year gilts 2 per cent.
Even from a multi-manager stance, the only government bond funds held by the Thames River Multi-Manager range are those able to short the gilts market.
Stewart Cowley, head of fixed income at Old Mutual Global Investors, feels that when long-dated bond yields go up it will be by at least 2 per cent and stresses that it is not a question of “if” this happens but “when” and “how quickly.” He points out that a 1 per cent rise in 30-year bond yields can result in a fall in capital value of more than 20 per cent, meaning that investors could experience equity-style losses from so-called “safe haven” holdings.
But other experts are quick to highlight that downside risk is reduced by the fact that bond funds commonly hold a spread of short and long-dated issues. Ben Bennett, head of credit strategy at Legal & General Investment Management, points out that if you bought every single constituent of the major sterling gilt indices in the right proportion then a 1 per cent rise in yield would result in roughly a 9 per cent fall in capital.
Philip Laing, head of rates at Standard Life Investments, agrees: “I think you will find that the vast majority of bond managers are suspicious of the valuation of their asset class and are certainly concerned about the prospect of a rise in yields at some point.”
There are also other cushions to consider. UK pension funds and insurance companies have to own significant quantities of bonds for regulatory reasons and the US Federal Reserve is still buying treasury bonds and could ramp up its purchasing if yields rise.
“It is absolutely key to realise that yields are being manipulated by central banks and that the actions of private investors can only have a limited impact,” says John McNeill, investment manager at Kames Capital.
“For example, the Bank of England owns approximately 30 per cent of the outstanding stock of gilts and a further 30 per cent are owned by overseas central banks.”
Furthermore, there is a limit to which even most private investors will bail out of this asset class. For example, Towry, the wealth manager, currently has its lowest ever exposure to government bonds, but it is not intending to reduce this any further “unless something extraordinary happens”.
Indeed, investors could even start seeing government bonds as representing value again if yields do rise. Ian Kernohan, economist at Royal London Asset Management, is expecting 10-year gilts to rise from 2 per cent to 2.9 per cent this year, and feels that they could start to look attractive at this level.
