Why bonds could still be a good buy for you as the bubble refuses to burst

The experts may be divided on them but they can have a place in private investors' portfolios, reports Julian Knight

Almost from the moment that the bond market shook off the malaise following the global financial crash - long before shares managed the same trick - there has been speculation that a bubble was developing. Long-standing market watchers did the numbers as long ago as 2011 and suggested that bonds were set for a battering. However, to date those predicting a crash have been proved spectacularly wrong as returns have continued to come in apace with lower-than-expected default rates. Although yields - in effect the amount of interest the bond earns - have fallen back as the economy has surged back into life and corporates and governments found it easier and cheaper to raise capital, bonds continue to play a more than healthy role in private investors' portfolios. Not so much crash as cruising along nicely.

"The bond bubble is a phrase I hate and I think many managers are beginning to regret using it. So many experts and top managers have presumed that we would have had dramatic falls by now but it hasn't happened," said Hargreaves Lansdown director Mark Dampier. "In some ways they have been a victim of presuming history will repeat itself. They look at previous experiences of emerging from recessions and market corrections and presume that by now we would start to see bonds as overpriced. However, this time around we are in a new world where interest rate cycles may only take us up to 2 or 3 per cent and as a result even these low bond yield rates could keep their attractiveness to investors."

There are two factors which have a major impact on the bond market and ultimately the fortunes of those who invest in bonds or bond funds. These factors are interest rates and the health of the economy. Generally, rising interest rates mean that the yield on bonds looks less attractive and therefore investors are likely to buy fewer. As for the wider economy, a troubled economy often means high default rates which can hurt bond returns and even lead to loss of capital, as Mr Dampier explains: "During the financial crash some bond funds lost half their value, high yield bonds in particular are a risky investment - that is why they pay a higher yield. Bonds are far from safe investments in the same way as cash."

The current economic and interest rate environment would suggest that bonds are not set to fall out of bed as they did in 2008 or as they have done following bubble scenarios in the past. Brian Dennehy, a director of Fundexpert, says the jury is very much out on bonds and the bursting of any bubble. In truth Mr Dennehy sees a soft landing for bond investors but nevertheless price declines are on the cards :"The average UK corporate bond fund made money in 2013, although not a lot, up 0.35 per cent. But it is difficult to see how corporate bond funds, on average, can do even this well in 2014. I say 'on average' deliberately. The worst such fund was down nearly 3 per cent in 2013, but the best were up a little over 5 per cent."

The trouble is that many bond fund managers have never had to deal with a difficult market - unless of course they were invested in high risk, high yield bonds at the time of the financial crisis - "the past 30 years has been bonanza time for bond fund managers, as yields have fallen from double digits, pushing up capital values, and often doing better than the stock market".

But that bull trend for bonds is probably over. And no bond fund manager has experience of having to make a turn in a long-term bear market for bonds. The best of them might well make money - derivatives provide much flexibility to slice and dice the bond returns, and even make money as capital values fall, Mr Dennehy says.

As a result, he cautions investors to reduce their exposure to bonds over the next year or two - anticipating at best sluggish returns if not outright falls.

Some bond fund managers though have been more pessimistic and suffered the consequences as a result. For instance, William Littlewood, renowned head of the Artemis Strategic Assets fund, is just one manager who has bet quite big on a falling market only to count the cost. Fortunately, Mr Littlewood's equity investments have ridden to the rescue. Other bond managers haven't been so lucky and as a result have underperformed: "Many of the managers have bet on a bursting of the bond bubble but have lost out as a result - some have been betting on it for two or three years," Mr Dampier said.

Yet Darius McDermott, managing director at Chelsea Financial Services, reckons that any growth to be had in bonds is going to come from managers like Mr Littlewood and the Jupiter and Henderson Strategic Bond funds (the Jupiter fund is also tipped by Mr Dampier) who are able to be nimble and hedge against bond values taking a dive.

"We've been saying for some time that if you do want to invest in bonds then strategic bond funds are the way to go. They have the flexibility to invest in all types of bond assets and find pockets of value where they do occur, and they have more tools available to them to manage interest rate risks better," Mr McDermott said. But this doesn't mean that he is a huge fan of bond investment right now. It seems his view is that strategic bond managers are best placed to make the best of a bad job.

"We would still struggle to say it is an attractive asset class... however, having said all this, bond funds do still play a valuable role in portfolios. Not only do they give diversification, but they are also a source of income, which is a necessity for many. As long as a bond fund is paying around 4 per cent, in our view it is a good source of income and the majority of returns going forward will be from the income rather than capital appreciation," he said. But that doesn't sound like the long-foretold bond market bubble bursting.

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

PROMOTED VIDEO
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

    Ashdown Group: Marketing Services Manager - (communications, testing, DM)

    £32000 - £35000 per annum + benefits: Ashdown Group: Marketing Services Manage...

    Guru Careers: Finance Account Manager

    £Neg. (DOE) + Excellent Benefits: Guru Careers: A Finance Account Manager with...

    Ashdown Group: Java Developer - Hertfordshire - £47,000 + bonus + benefits

    £40000 - £470000 per annum + bonus: Ashdown Group: Java Developer / J2EE Devel...

    Ashdown Group: Direct Marketing Manager - B2C, Financial Services - Slough

    £45000 - £55000 per annum + Benefits: Ashdown Group: An exciting opportunity h...

    Day In a Page

    Jeb Bush vs Hillary Clinton: The power dynamics of the two first families

    Jeb Bush vs Hillary Clinton

    Karen Tumulty explores the power dynamics of the two first families
    Stockholm is rivalling Silicon Valley with a hotbed of technology start-ups

    Stockholm is rivalling Silicon Valley

    The Swedish capital is home to two of the most popular video games in the world, as well as thousands of technology start-ups worth hundreds of millions of pounds – and it's all happened since 2009
    Did Japanese workers really get their symbols mixed up and display Santa on a crucifix?

    Crucified Santa: Urban myth refuses to die

    The story goes that Japanese store workers created a life-size effigy of a smiling "Father Kurisumasu" attached to a facsimile of Our Lord's final instrument of torture
    Jennifer Saunders and Kate Moss join David Walliams on set for TV adaptation of The Boy in the Dress

    The Boy in the Dress: On set with the stars

    Walliams' story about a boy who goes to school in a dress will be shown this Christmas
    La Famille Bélier is being touted as this year's Amelie - so why are many in the deaf community outraged by it?

    Deaf community outraged by La Famille Bélier

    The new film tells the story of a deaf-mute farming family and is being touted as this year's Amelie
    10 best high-end laptops

    10 best high-end laptops

    From lightweight and zippy devices to gaming beasts, we test the latest in top-spec portable computers
    Michael Carberry: ‘After such a tough time, I’m not sure I will stay in the game’

    Michael Carberry: ‘After such a tough time, I’m not sure I will stay in the game’

    The batsman has grown disillusioned after England’s Ashes debacle and allegations linking him to the Pietersen affair
    Susie Wolff: A driving force in battle for equality behind the wheel

    Susie Wolff: A driving force in battle for equality behind the wheel

    The Williams driver has had plenty of doubters, but hopes she will be judged by her ability in the cockpit
    Adam Gemili interview: 'No abs Adam' plans to muscle in on Usain Bolt's turf

    'No abs Adam' plans to muscle in on Usain Bolt's turf

    After a year touched by tragedy, Adam Gemili wants to become the sixth Briton to run a sub-10sec 100m
    Calls for a military mental health 'quality mark'

    Homeless Veterans campaign

    Expert calls for military mental health 'quality mark'
    Racton Man: Analysis shows famous skeleton was a 6ft Bronze Age superman

    Meet Racton Man

    Analysis shows famous skeleton was a 6ft Bronze Age superman
    Garden Bridge: St Paul’s adds to £175m project’s troubled waters

    Garden Bridge

    St Paul’s adds to £175m project’s troubled waters
    Stuff your own Christmas mouse ornament: An evening class in taxidermy with a festive feel

    Stuff your own Christmas mouse ornament

    An evening class in taxidermy with a festive feel
    Joint Enterprise: The legal doctrine which critics say has caused hundreds of miscarriages of justice

    Joint Enterprise

    The legal doctrine which critics say has caused hundreds of miscarriages of justice
    Freud and Eros: Love, Lust and Longing at the Freud Museum: Objects of Desire

    Freud and Eros

    Love, Lust and Longing at the Freud Museum