Jeff Salway offers words of reassurance as well as some options for savers and investors worried by recent movements in the markets
Global bond markets have lost more than $456 billion (£290bn) in value in recent weeks amid a government debt sell-off that has also triggered some uncertainty in stock markets.
The downturn began in mid-April as inflation expectations driven by a modest improvement in oil prices prompted investors to shift out of bonds they bought as a protection against deflation.
Those deflation fears had boosted the appeal of government bonds (gilts), resulting in many investors buying government bonds with “negative” or very low yields. Some of the biggest demand was for German bunds, the yields on which have risen over the past month as deflation expectations have eased, the Eurozone recovery has strengthened and the European Central Bank’s quantitative easing programme – used to buy bonds – has boosted demand.
Yields have also edged up on ten-year bonds issued by countries including the UK, the US – each reaching their highest level since last November – France, the Netherlands, Spain and Italy.
Jason Hollands, managing director of Tilney Bestinvest, said: “Bonds more than any other asset class have been distorted by the misallocation of capital from central bank stimulus programmes and the ultra-low interest rates seen across much of the globe in the aftermath of the financial crisis.
“This probably isn’t the decisive pricking of the so-called bond bubble, but it certainly provides a warning shot of how swiftly prices and yields can move.”
Millions of people have exposure to gilts through personal and workplace pension funds (including final salary schemes) and Isas.
Nigel Green, chief executive of deVere Group, a financial adviser, said: “It is still unclear whether we’re about to enter the end of the incredible three-decade bond market rally – but what we do know is that the currently tumbling bond market is pushing company pension deficits even further into the red. As such, the bond market sell-off is threatening the retirement incomes and ambitions of a large number of workers.”
He warned pension savers not to “wrongly assume” that their retirement funds were safe. “I would urge people to have their company pensions checked sooner rather than later. This is because it is likely that their values could fall further as most trustees have already made almost every change possible, such as raising retirement age and amending the amount of pension increases, yet the schemes remain extremely vulnerable,” said Green.
But Barry O’Neill, investment director at Carbon Financial Partners, cautioned against dumping gilts entirely in response to the recent sell-off. “The harbingers of doom have been predicting a bloodbath in bond markets for the last three years at least,” he said. “Anyone heeding that advice would have lost out on some very healthy returns in the interim.”
So what are your options if you’re invested in gilts and are worried about movements in the market? Corporate bonds – debt issued by companies rather than governments – are a popular option. But investors looking at moving into corporate bonds should be aware of their close correlation with gilts, according to Anthony Doyle, of M&G Investments.
“Subsequently, any sell-off in government bond markets will likely hit investment grade corporate bond returns as well,” said Doyle.
There are still areas of value in bonds, even though the overall market is down, O’Neill pointed out.
“If you had based your bond exposure on academic research you would have bought the highest quality, shortest dated bonds around the world, rather than concentrating your exposure on the longer dated end of the UK market,” he said.
“Funds investing in such truly diversified issues have to date not posted negative returns and although they can’t guarantee to avoid a fall in prices, should be least affected. Basically, the longer dated and lower quality issues suffer most when there is a sell off.”
One option available is to invest in so-called “strategic” bond funds, where the manager shifts between different types of bonds in response to changes in the market. There are concerns over these products, however, with some experts highlighting a level of “manager risk” that might not usually be an issue in bond funds.
“Some people’s answer is to entrust an active manager to move up and down the credit quality and term spectrum according to economic conditions, but this relies on the mistaken belief that active managers can predict the future and postpone their portfolios to take advantage of what’s to come,” said O’Neill.
“All of the research into this suggests otherwise, so you run the risk of getting the timing of these decisions badly wrong and destroying value. I’d rather trust decades of academic research that the supposed skill of an individual manager to outsmart the rest of the market.”