Mark Dampier: Bonds can still be worth buying despite the Fed's shock move on tapering
Friday 27 September 2013
I last reviewed the Royal London Sterling Extra Yield Bond Fund in May this year. Given the continued news flow on bonds I thought it was worth a revisit. It is no secret that most commentators and analysts, including me, felt that bonds issued by the UK, US and German governments looked overpriced when ten-year yields fell to record low levels of around 1.5 per cent.
This year yields have risen to around 3 per cent and prices have correspondingly fallen. This is partly because the US government suggested it would begin to slow its quantitative easing programme, which currently involves buying huge quantities of bonds. Last week markets were surprised when the Federal Reserve decided to postpone this "tapering", and yields have since fallen again. That said, I think it is only a postponement and we could see bond purchases slow later this year.
Sovereign bonds tend to be bought mainly by institutional investors such as pension funds and insurance companies. Most private investors focus in their Isa or Sipp portfolios on corporate bonds which are issued by companies and linked to their creditworthiness. However, their pricing still tends to be linked to government bonds, although within this there is a degree of what might be termed fair value.
Royal London's Eric Holt suggests the yield on ten-year UK government bonds, or gilts, might hit 3.25 per cent next year. Longer term he believes fair value might be 5 per cent, implying further price falls and weakening the case for buying them. He believes yields are at about the right level. Countries in Europe, including the UK, still have big budget deficits and he sees little risk of inflation getting out of control soon. Inflation risks tend to be centred on energy and food prices which central banks can't really control.
With corporate bonds yielding about 1.5 per cent more than gilts, he sees some value in this area of the market. He suggests the gap could fall back to around 1 per cent as many corporations have got their acts together in terms of their financial strength.
The dilemma facing investors is that while government bond yields may creep up there seems little sign that short-term interest rates are likely to rise soon. In the UK the market is pricing in the first interest rate move before the next general election, but the market is usually wrong. Greater cynicism would suggest after the next general election would be the earliest potential date for a rise. This means investors negative on bonds either have to suffer short-term cash rates of about 1.5 per cent gross or rotate into the equity market. It might sound sensible, but if there was a rout in the bond market it would hit equity markets too. Indeed, the Federal Reserve's announcement of a possible tapering of QE was enough to send equities falling much further than bonds.
The Royal London Sterling Extra Yield Bond Fund currently has 38 per cent exposure to high-yield bonds. Mr Holt recognises that yields in this area of the market are close to record lows. However, he also notes that many issuers of high-yield bonds are actually high-quality businesses with less bank debt (which ranks ahead of their bonds in order of repayment) than in the past. There has been a lot of bank-to-bond refinancing (swapping bank loans for bond issues) and he believes these companies are well-placed to meet their obligations.
Mr Holt says the high-yield market is not overvalued, but is more fair value. An attractive level of income remains on offer for investors with a long-term horizon. The fund currently offers a yield of 7.2 per cent, according to Mr Holt, well diversified with 177 holdings.
Many buy-to-let investors are happy to buy illiquid property with yields of only 5 to 6 per cent. No one asks them whether, if interest rates rise in future, will they still want to hold property?
With a yield of above 6 per cent there is some safety margin built in to this fund, while it also looks more defensive than an equity portfolio. I remain wary of the impact a rise in interest rates could have on investment-grade corporate bond funds, but still think there is room for a fund such as this in an investment portfolio.
Mark Dampier is head of research at Hargreaves Lansdown, the asset manager, financial adviser and stockbroker. For more details about the funds included in this column, visit hl.co.uk/independent
First full-length look is finally here
World cities ranked in terms of safety, food security and 'liveability'
- 1 Saudi preacher who 'raped and tortured' his five -year-old daughter to death is released after paying 'blood money'
- 2 The awkward moment Sarah Palin raised $25,000 for Hillary Clinton's election campaign
- 3 Ball pool for adults opens in London
- 4 Amal Clooney gives excellent response to fashion question at European Court of Human Rights
- 5 Baldness could soon be treated using stem cells, scientists hope
9 reasons Greece's experiment with the radical left is doomed to failure
'We would evict Queen from Buckingham Palace and allocate her council house,' say Greens
Have we reached 'peak food'? Shortages loom as global production rates slow
Greece elections: Syriza and EU on collision course after election win for left-wing party
British grandmother Lindsay Sandiford faces execution by firing squad in Indonesia
Liberal Democrat minister defends comments suggesting immigration causes pub closures
iJobs Money & Business
£30000 - £35000 per annum + Benefits: Ashdown Group: Marketing Manager - Marke...
£13000 per annum: Recruitment Genius: This Pension Specialist was established ...
£23000 - £26000 per annum + Benefits: Ashdown Group: Market Research Executive...
£25000 - £35000 per annum: Recruitment Genius: A Technical Report Writer is re...
Day In a Page
A minimnalist four-bedroom home designed to the highest spec, featuring glass walls and a kitchen space lit by a glass roof
Hibernate during winter and make your living during the summer at this busy guesthouse with panoramic sea views, in the village of Lynton
A four-bedroom penthouse next to the Tate with direct views of St Paul's from two floors of luxurious living space
A four-bedroom detached home surrounded by spacious gardens and woodland, close to New Pudsey
An 18th-century, three-bedroom home near Langstone Harbour built from ships beams with vaulted ceilings and wood burning stoves
A five-bedroom semi-detached home with a mix of period and modern features in a popular and convenient location
This five-bedroom red-brick beauty overlooks the village green and sits in just under two acres of land
A three-bedroom villa with self-contained flat, minutes from Lake Windermere
A deceptively spacious, beautifully presented Georgian home with 3000sq ft of living space and five reception rooms
A five-bedroom Victorian home with four receptions, superb gardens and paddock in Pembury
An eight-bedroom house on the south side of the The Green with cinema, wine cellars and summer house
This 17th century beauty is full of rustic cosiness, while the detached home office means you can also run a business
Four exclusive apartments in a Grade II-listed former medical school with 2,275 sq ft of living space and 18ft ceilings
A five-bedroom terraced house on the popular Peterborough Estate, ideally located for both Eel Brook Common and South Park
A state-of-the-art farm-building conversion on the former Cliveden Estate, with 11,420sq ft of internal space, cinema and wine cellar
A three-bedroom, 15th-century cottage with original features in the picturesque village of Sissinghurst
A six-bedroom terraced house with large south-facing roof terrace, cinema room and wine cellar
A new seven-bedroom home built in Queen Anne-style with swimming pool and parkland views in Mortimer
A listed, four-bedroom farmhouse in the rural hamlet of Rushall with detached barn, four acres of gardens and paddocks
A first-floor flat with two bedrooms, a spacious reception room and communal grounds in a leafy part of London
A three-bedroom flat with a spacious rootop terrace and balcony, accessed from a private gated courtyard
A Grade II-listed pile with six bedrooms, stables and 39 acres of grounds in Standlake
A two-bedroom flat with boutique hotel-style interiors, close to the foodie haunt of West End Lane
A two-bedroom flat in a beautiful old vicarage, with many original features, close to the city centre
A three-bedroom 16th-century home with an aga kitchen, private gardens and heated outdoor pool, in Hadleigh
A three-bedrom home in sought-after Queen's Gate Mews, with Italian marble-finished bathrooms
Surrounded by glorious countryside in the village of Udimore, sits this impressive four-kiln oast and barn conversion
A five-bedroom house in the picturesque village of Kettlewell, north Yorkshire
An 18th-century former coaching inn with original staircase, open fireplaces and beams throughout
A Grade II-listed Georgian town house with three bedrooms and a south-facing courtyard, near Arundel Castle
Feel on top of the world at this über chic penthouse on the 37th floor of one of Europe’s tallest blocks.
A Grade II-listed Victorian villa with six bedrooms and two further cottages, all with spectacular sea views
A grade II-listed, Georgian cottage with mature 50ft garden, perfect for summer entertaining
A magnificent Georgian pile with turrets, seven bedrooms, a heated pool and four acres of gardens
Fairoak Farm has five bedroom suites, gym, outdoor swimming pool and golf course
Chic two-bedroom river-fronted flat with a private lift that delivers you directly to your home
A spectacular seven-bedroom Tudor pile, once owned by Henry VIII, with 18 acres of land
A seven-bedroom Georgian property previously used as a picturesque wedding venue
A split-level flat in a church conversion with two en suite bedrooms and 1,200sq ft of living space
A three-bedroom bungalow situated behind an impressive stone wall, £645,000
Windsor Castle overlooks this three-bedroom Victorian cottage located on one of Windsor's smartest roads
Chapel House is a former vicarage with nine bedrooms in the beautiful Upper Wye Valley
A five-bedroom B&B and separate owner's accomodation with potential for conversion