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
Saturday 26 April 2014
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
Sales of the tablet are set to fall again say analysts
World's most lethal spider found under a bunch of bananas
Rumours that the star wants to move on to pastures new
Comedian says he 'never laughed as hard as I have writing with Rik'
The HiFX guide to international money transfers
Mark Dampier: Woodford’s young companies could be the stars of the future
Charges related to car parking rising and leading to serious money woes
Money Insider: Help to Buy must be boosted by building
Weekly Money: Round-up of the personal finance stories you may have missed 13-17 October
- 1 Jack the Ripper: Scientists who claims to have identified notorious killer has 'made serious DNA error'
- 2 Ebola outbreak: What is bushmeat – and is it to blame for the disease that has killed thousands?
- 4 Meet Thea, Norway's 12-year-old child bride
Cameron is warned 'no possibility' of UK reducing immigration and that bid to bring in quota on migrant workers would be illegal
Sorry Judy Finnigan – Ched Evans is no less sickening than an alleyway rapist
Residents should throw a street party and mix with immigrant neighbours, councils told
Workers 'could be forced to pay £5 a week' to get benefits
Russell Brand threatened with arrest after filming outside Fox News headquarters
Amal Alamuddin calls for the return of the Elgin Marbles from Britain: 'Injustice has persisted for too long'
iJobs Money & Business
£60 - 65k + Benefits: Guru Careers: We are seeking a ASP.NET Web Developer / ....
£60,000 - £80,000: Saxton Leigh: Our client is an leading Asset Manager based...
£27000 - £32000 Per Annum: Clearwater People Solutions Ltd: Our large charity ...
£50000 - £55000 per annum + bonus + benefits: Ashdown Group: IT Relationship M...
Day In a Page
This 17th century beauty is full of rustic cosiness, while the detached home office means you can also run a business
This five-bedroom red-brick beauty overlooks the village green and sits in just under two acres of land
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
Enjoy summer by the Thames in this two double-bedroom converted warehouse in Rotherhithe village
A one-bedroom, luxury apartment with private gym and concierge service in Moorgate
A four-bedroom house in Hermitage Gardens with three reception rooms and landscaped gardens
A seven-bedroom Grade II-listed property with a separate self-contained apartment
A five-bedroom Victorian house with three reception rooms and galleried landing, £695,000
A six-bedroom farmhouse with five acres of land in a former cloth-making village