Mark Dampier: Don't write off bond exposure just yet

It is still difficult to see interest rates in the UK rising before the next general election.

Bonds have been in the spotlight ever since Ben Bernanke, chairman of the US Federal Reserve, suggested American quantitative easing could be tapered this year. Investors interpreted this as the first stage towards an rise in interest rates, which would be negative for bond markets.

Bonds pay a fixed level of income, which looks less attractive against a backdrop of rising interest rates. Bond prices have therefore fallen in recent weeks, and yields (the fixed income divided by the price and expressed as a percentage) have correspondingly risen. Equity markets were also hit, perhaps as investors saw an excuse for profit taking after a strong run. In both cases emerging markets fared worst, with equity and bond markets falling around 10 per cent.

I think even Mr Bernanke was surprised by the reaction of investors. While equity market falls could be put down to profit taking, for bonds the problem is somewhat greater. Bonds have enjoyed a bull market since 1990 and yields are at historic lows. Everyone knows interest rates will have to go up one day. The trouble is neither commentators nor central bankers really know when. That day must be drawing closer.

Investors face a conundrum. While sovereign debt, such as gilts and US treasuries, doesn't yield much it is still possible to get yields of around 3 per cent from corporate bonds. This compares favourably with UK deposit rates, which have fallen further to no more than around 1.5 per cent, but it does involve taking some capital risk.

For investors who still want some bond exposure I believe strategic bond funds should be considered. These give managers the freedom to invest across the fixed-income spectrum, wherever they see the best opportunities. They also have the flexibility to use derivatives and alternative techniques such as shorting, to provide some relative capital protection in a falling bond market. This is of course reliant on the fund managers making the correct decisions and there are no guarantees.

One of my favourite funds in this area is the Invesco Perpetual Tactical Bond fund, managed by Paul Read and Paul Causer. The fund has no constraints over geography, sector or credit quality. It is a portfolio of their very best ideas with a focus on generating a combination of capital growth and income over the long term, rather than focusing solely on income. Key to their approach is identifying undervalued opportunities which they believe will add significant value when markets are rising. They will also seek to shelter capital when opportunities are lacking.

The managers began shifting the portfolio to a more defensive stance before Mr Bernanke's speech. They held a significant cash position, but were still achieving a portfolio yield in the region of 5 per cent. They expect the recent falls to be the first stage in the global readjustment brought about by a stronger US economy. Despite their sombre outlook they believe ongoing volatility will continue to throw up good opportunities.

Overall the cash and short-dated bond positions (the managers view short-dated and government bonds as near-cash positions which can be sold quickly) comprise around 60 per cent of the portfolio. They suggest the portfolio should therefore be well positioned for turbulence and with sufficient liquidity to take advantage of buying opportunities.

The balance of the portfolio is largely invested in the financial sector and this remains an important component of Mr Read and Mr Causer's strategy. On balance they have been rewarded for the risks taken in this area of the market. However, exposure to higher-risk high-yield bonds and financial bonds has recently been reduced. They continue to believe yields are attractive in this area of the market, but see less scope for capital growth as the sector has rallied over the past year.

For investors cognisant to the risks in the bond market, but still wanting some exposure, the Invesco Perpetual Tactical Bond fund could be an ideal component of a well-diversified bond portfolio. It is still difficult to see interest rates in the UK rising before the next general election in May 2015 and income is still a priority for many investors. I am therefore not sure the bond story is entirely over. That said, investors must recognise we are at the beginning of the end of the bond story and the eventual transition to higher interest rates will not be an easy one.

Mark Dampier is head of research at Hargreaves Lansdown, the asset manager, financial advisor and stockbroker. For more details about the funds included in this column, visit www.hl.co.uk/independent

Independent Partners; request a free guide on NISAs from Hargreaves Lansdown

Voices
There will be a chance to bid for a rare example of the SAS Diary, collated by a former member of the regiment in the aftermath of World War II but only published – in a limited run of just 5,000 – in 2011
charity appealTime is running out to secure your favourite lot as our auction closes at 2pm today
News
people
News
Elton John and David Furnish exchange marriage vows
peopleSinger posts pictures of nuptials throughout the day
News
File: James Woods attends the 52nd New York Film Festival at Walter Reade Theater on September 27, 2014
peopleActor was tweeting in wake of NYPD police shooting
PROMOTED VIDEO
Sport
Martin Skrtel heads in the dramatic equaliser
SPORTLiverpool vs Arsenal match report: Bandaged Martin Skrtel heads home in the 97th-minute
News
Billie Whitelaw was best known for her close collaboration with playwright Samuel Beckett, here performing in a Beckett Trilogy at The Riverside Studios, Hammersmith
people'Omen' star was best known for stage work with Samuel Beckett
Arts and Entertainment
Mark Wright has won The Apprentice 2014
tvThe Apprentice 2014 final
News
i100
Arts and Entertainment
Darrell Banks’s ‘Open The Door To Your Heart’
music
News
Detective Tam Bui works for the Toronto Police force
news
Finacial products from our partners
Property search
Latest stories from i100
Have you tried new the Independent Digital Edition apps?
Independent Dating
and  

By clicking 'Search' you
are agreeing to our
Terms of Use.

ES Rentals

    iJobs Job Widget
    iJobs Money & Business

    SThree: Trainee Recruitment Consultant - LONDON

    £20000 - £25000 per annum + OTE £40,000 + Car + Pension: SThree: SThree are a ...

    SThree: Trainee Recruitment Consultant

    £20000 - £25000 per annum + OTE £35K: SThree: We consistently strive to be the...

    SThree: Graduate Recruitment Consultant

    £20000 - £25000 per annum + OTE £35000: SThree: SThree are a global FTSE 250 b...

    SThree: Trainee Recruitment Consultant

    £20000 - £25000 per annum + OTE £35K - £45K: SThree: SThree Group have been we...

    Day In a Page

    Surrounded by high-rise flats is a little house filled with Lebanon’s history - clocks, rifles, frogmen’s uniforms and colonial helmets

    Clocks, rifles, swords, frogmen’s uniforms

    Surrounded by high-rise flats is a little house filled with Lebanon’s history
    Return to Gaza: Four months on, the wounds left by Israel's bombardment have not yet healed

    Four months after the bombardment, Gaza’s wounds are yet to heal

    Kim Sengupta is reunited with a man whose plight mirrors the suffering of the Palestinian people
    Gastric surgery: Is it really the answer to the UK's obesity epidemic?

    Is gastric surgery really the answer to the UK's obesity epidemic?

    Critics argue that it’s crazy to operate on healthy people just to stop them eating
    Homeless Veterans appeal: Christmas charity auction Part 2 - now LIVE

    Homeless Veterans appeal: Christmas charity auction

    Bid on original art, or trips of a lifetime to Africa or the 'Corrie' set, and help Homeless Veterans
    Pantomime rings the changes to welcome autistic theatre-goers

    Autism-friendly theatre

    Pantomime leads the pack in quest to welcome all
    The week Hollywood got scared and had to grow up a bit

    The week Hollywood got scared and had to grow up a bit

    Sony suffered a chorus of disapproval after it withdrew 'The Interview', but it's not too late for it to take a stand, says Joan Smith
    From Widow Twankey to Mother Goose, how do the men who play panto dames get themselves ready for the performance of a lifetime?

    Panto dames: before and after

    From Widow Twankey to Mother Goose, how do the men who play panto dames get themselves ready for the performance of a lifetime?
    Thirties murder mystery novel is surprise runaway Christmas hit

    Thirties murder mystery novel is surprise runaway Christmas hit

    Booksellers say readers are turning away from dark modern thrillers and back to the golden age of crime writing
    Anne-Marie Huby: 'Charities deserve the best,' says founder of JustGiving

    Anne-Marie Huby: 'Charities deserve the best'

    Ten million of us have used the JustGiving website to donate to good causes. Its co-founder says that being dynamic is as important as being kind
    The botanist who hunts for giant trees at Kew Gardens

    The man who hunts giants

    A Kew Gardens botanist has found 25 new large tree species - and he's sure there are more out there
    The 12 ways of Christmas: Spare a thought for those who will be working to keep others safe during the festive season

    The 12 ways of Christmas

    We speak to a dozen people who will be working to keep others safe, happy and healthy over the holidays
    Birdwatching men have a lot in common with their feathered friends, new study shows

    The male exhibits strange behaviour

    A new study shows that birdwatching men have a lot in common with their feathered friends...
    Diaries of Evelyn Waugh, Virginia Woolf and Noël Coward reveal how they coped with the December blues

    Famous diaries: Christmas week in history

    Noël Coward parties into the night, Alan Clark bemoans the cost of servants, Evelyn Waugh ponders his drinking…
    From noble to narky, the fall of the open letter

    From noble to narky, the fall of the open letter

    The great tradition of St Paul and Zola reached its nadir with a hungry worker's rant to Russell Brand, says DJ Taylor
    A Christmas ghost story by Alison Moore: A prodigal daughter has a breakthrough

    A Christmas ghost story by Alison Moore

    The story was published earlier this month in 'Poor Souls' Light: Seven Curious Tales'