While some investors have written-off bonds in favour of cash, Chris Metcalfe, chief investment officer at Iboss, says this ignores their longer-term role in risk management and return generation.
“In recent years many investors have become complacent about the risks that equities face, especially parts of the US market where prices have been driven up by free money during the pandemic and subsequently by artificial intelligence. Once investors’ attitude to bonds is seen through this lens, the reluctance by many to invest starts to make more sense.”
Additionally, bonds have been underperforming equities in recent years, says Richard Carter, head of fixed interest research at Quilter Cheviot. “This has not been helped by a rise in both inflation and interest rates, although corporate debt has held up better than government bonds.”
Some bonds have also been underperforming cash-like alternatives.
Recently in the UK the yield curve has been inverted, says Henry Cobbe, head of research at Elston Consulting. “So overnight rates, reflected in money market funds, have been higher than longer dated bonds, without the volatility or duration risk.”
Matthew Parkinson, a fund manager at Waverton Investment Management, also describes the past few years as having been “incredibly challenging” for fixed income.
“However, given the extent of the repricing we have seen in government bonds, in particular UK gilts, we now believe yields reflect an environment that more closely resembles the pre-global financial crisis era of modestly higher growth and inflation, versus the post-GFC era of no growth nor inflation.
“If this environment continues, we will happily clip our circa 5 per cent coupon and let equities do the heavy lifting in portfolios. However, if this scenario does not play out, government bonds’ defensive characteristics become very attractive.”
A diversifier once more
Bond yields are currently quite high by historical standards, says Carter, particularly in regions such as the US and UK, and theoretically look to be of reasonable value when compared to equities.
“However, while it has been challenged in some areas of late, equities are likely to continue to offer better returns if global economic growth remains fairly buoyant,” he adds.
Oli Jones, an investment analyst at PortfolioMetrix, a discretionary investment manager, also points to yields across all fixed income asset classes being at, or around, the highest levels seen for a long time.
Jones says: “The elevated starting yields across the board now mean bonds again offer protection in multi-asset portfolios.
“The higher starting yields help cushion any falls; and interest rates would need to go meaningfully higher from here to generate negative total returns, assuming no defaults, over the short to medium term.”