Many people have predicted the imminent demise of the bond market over the last couple of years. Their reasoning has been logical: interest rates are a historic lows, and the next moves are surely upwards, which would cause bonds to fall in value.
Yet the situation is more complicated. Interest rates have still not risen in the UK, and it seems unlikely to me they will rise this year. Even in 2012, the likelihood of a rise must now be quite faint given the background of an anaemic economic recovery. With interest rates as such low levels, bond funds yielding five per cent or more surely still look attractive?
One fund I am very keen on is Jupiter Strategic Bond, managed by Ariel Bezalel, which has just come up to its three-year anniversary. Over this time it is up around 46 per cent versus around 17 per cent for the strategic bond sector.
Clearly, he's done a good job so far. However, sovereign debt issues are still troubling bond investors. Greece of course is the major concern at the moment, and the problems facing Portugal and Ireland are not far behind. Indeed, the most significant problem in the world today is that too much debt is owed by countries whose ability to pay it back is questionable.
The West as a whole, including the UK and the US, face huge challenges of mounting debt and budget deficits. In the case of Greece, the debt mountain is so large I see no chance of it being paid back in full, and I doubt whether the Irish or Portuguese will be any different.
There is a risk of contagion, and Mr Bezalel has taken a somewhat defensive stance with his portfolio this year. In banks, he is only exposed to the UK and Germany on the basis the UK economy can be cushioned by a weaker pound, and that the Germans, while heavily exposed to Greek debt, are at least in a strong position to absorb the impact in the event of default.
Interestingly, he has added to positions in Australian and Canadian government bonds. Australia has net debt to GDP of just 7 per cent and Mr Bezalel believes bonds there are a safe haven asset. His theory is that as growth in emerging market slows, it will take the heat out of the Australian economy leading to interest rates being cut – good news for the capital values of government bonds.
However, he is mindful of the impact this might have on the Australian Dollar, and he has hedged against any deterioration of this and the Canadian Dollar against the pound.
Mr Bezalel is not trying to be a hero by investing aggressively amidst an uncertain economic backdrop. The developing crisis in Greece is creating major political and economic uncertainty, and has huge ramifications for all markets.
However, I don't think the time is right to turn bearish on bonds as a whole. With interest rates set to remain low for some time there are still opportunities to pick up good levels of income. Indeed this fund yields around 5 per cent presently.
That said, Mr Bezalel cautions that income will be the chief component of returns over the next six months or so, and I am inclined to agree. Whilst he is less well known than the star fund managers of the bond sectors, if I was to pick a star of the future, he would certainly be on my shortlist.
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 www.h-l.co.uk/independentReuse content