Mark Dampier: It's no use crying over risk, look at the value in bond markets
Friday 17 January 2014
In 1990 interest rates were at 15 per cent. You didn't need to be brain of Britain to know that rates at that level were not going to last. It should be easy, therefore, to look at interest rates today – standing at 0.5 per cent – and see this must be the bottom of the interest rate cycle, with little chance of them remaining at record lows in the medium to long term.
Unfortunately, while history often rhymes it doesn't always repeat exactly. Interest rates have been at 0.5 per cent for five years, confounding just about every expert I can think of. It also meant the bears of the bond markets were calling time too soon. As early as 2009 I saw one article exclaiming the bond rally was over. It had hardly started. Even the great Bill Gross, manager of one of the world's largest bond funds, made a fool of himself suggesting gilts were "sitting on a bed of nitroglycerin" and would blow up at any time. If I recall correctly, 10-year gilt yields were around 4 per cent then and subsequently fell below 1.5 per cent.
Hindsight is a wonderful thing. Yet after five years I believe we are nearing the end of record low interest rates. I don't see them rising before the next general election, but I am a cynic when it comes to electoral cycles.
For investors, the real question is whether there is any value left in bonds. Paul Read and Paul Causer of Invesco Perpetual, two of the best bond fund managers around, suggested in 2009 that there were lots of risks but also lots of value in bond markets. They took the risk and delivered on performance, but now feel Armageddon has been averted and the European banking system is in better shape. The rewards available for taking extra risk are no longer as great.
It therefore makes sense for investors seeking fixed-interest exposure to choose a flexible fund such as Invesco Perpetual Tactical Bond. This allows the managers to combine strategies designed to protect capital and generate income, varying their positioning depending on their views and where they see opportunities.
Presently, they see little value in government bonds, despite 10-year gilt yields having moved from 1.5 per cent to 3 per cent. Working out how painful any sell-off could be is challenging, though, as they believe central banks will keep interest rates low in the short term. Government bond exposure is confined to shorter dated bonds where they believe a better return is available than on cash, but they can be sold easily when opportunities arise.
In a recent meeting Paul Causer said to me "bond markets are as strong as their weakest link and the weak link is the [high yield] part of the market which has seen lots of issuance, much not of a great quality". Heavily indebted companies, weak corporate structures, and low cash flows are a recipe for disaster. They see the market as reaching a peak, but don't expect sharp falls initially.
What is interesting is for the first time in a while there is no big theme running through the portfolio. They are generally positioned cautiously with 43 per cent in short-dated bonds and cash, to keep volatility down. They will also continue to take profits from positions on any further strength, waiting for opportunities to invest in high quality bonds. There is also 40 per cent invested in bank bonds, including 20 per cent in higher risk bank bonds; and some exposure to the US dollar.
Looking ahead they believe it will be a difficult year in which to make any real capital return, but they believe the economic background is good, so do not expect disaster to come from here. They plan to focus on higher quality bonds and defending the value of investors' capital while they wait for higher return opportunities to arise.
Messrs Read and Causer always tell it as they see it, and over the years I have come to trust their judgement. They can be early in their calls, but always make up for it over the long term. If they see little opportunity perhaps this is the time to move into funds which have greater flexibility to protect capital and wait patiently for future opportunities. Invesco Perpetual Tactical Bond is one of these funds and this is the reason I hold it in my own 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
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