The relatively high yields and current volatility in the bond markets has opened up opportunities for investors.
Stuart Clark, portfolio manager of the Quilter Wealth Select Managed Portfolio Service, says the current government bond market is more attractive than it has been in previous years, despite ongoing uncertainty and volatility, not least surrounding Donald Trump’s second term as US president.
He says: “The opportunity is a combination of the higher starting yield for clients, making it more attractive relative to cash, and for us, hopefully, as professional investors, the volatility giving us opportunities to capture additional sources of return.”
Gilt yields surged in the opening weeks of 2025, with the 10-year gilt yield reaching a high of 4.91 per cent in mid January before falling back to 4.57 per cent by the end of the month. The two-year gilt reached highs of about 4.6 per cent and then fell back to 4.25 per cent.
In response to January’s gilt moves Wealth Select increased the fixed income allocation in its mixed assets portfolios, following an earlier rebalance in October, in which it swapped about 4 per cent of its overweight position in bonds into liquid alternatives.
Clark says the team saw an opportunity in gilts as rate cuts at the time had not been priced in for UK government bonds, whereas they had been for treasuries.
“It seemed like a fair pricing and a good starting yield for treasuries, whereas for the gilt market, we saw the opportunity for some additional rate cuts to come through if growth was struggling and the Bank of England were to prioritise that side of the equation more so than the inflation fighting element,” Clark adds.
One source of uncertainty is Trump.
Some of his policies, as proclaimed during his election bid, are perceived to be inflationary, such as slapping high tariffs on US trading partners. Others could add counterbalance, such as his undoing of Joe Bidens’ green energy policies.
We’re going to be monitoring those drivers of inflation, and certainly core inflation in the US, quite closely.
But whether, on whom, and when tariffs will be levied is uncertain and could change at a moment’s notice.
Clark says: “The difficulty for some managers looking at the way they manage overall risk within the portfolio is trying to think about where the volatility in the bond market is going to settle, and what other unknowns are about to be thrown at us, and let’s hope that there aren’t too many of them.”
He adds: “It would seem for president Trump that he would try to avoid stoking further inflation where possible.
“So we are cognisant of the risk, and we’re going to be monitoring those drivers of inflation, and certainly core inflation in the US, quite closely.”
In late January the US Federal Reserve held interest rates amid concerns about inflation, a move that stoked Trump, who wants rates cut and who immediately turned to his platform Truth Social to proclaim his anger.
But Clark says he is more concerned about stickier inflation in the UK over factors such as higher energy prices, higher wages or the government’s national insurance rises for businesses trickling through, and the effect higher yields could have on government spending.
“There’s a much finer balancing act in the UK when it comes to rates and inflation, I think, and we are slightly more at risk at home of seeing slightly higher inflationary pressures coming through,” he notes.
Though with this comes opportunity. As Clark’s colleague portfolio manager Helen Bradshaw points out, the UK had weaker growth, which made a rate cut more likely.
She says: “It’ll be a slightly more difficult decision for the BoE, where you’ve got on the one hand slowing growth, but at the other hand more inflationary pressures that are building up.
“So I think that will be a finer balance for them to manage.”
Sticking to the benchmark
Overall, the managers expect what they called a range-bound trading environment this year on government bonds, meaning no extreme swings, but with persistent and high levels of volatility.
Wealth Select does not rely on bonds alone to diversify its portfolios, it splits its diversifiers into fixed income, liquid diversifiers and cash, held alongside mainly equities.
However, it has started to rebuild some of the traditional fixed income positions in the portfolios because the starting yields on government bonds are attractive.
At the same time, Clark says, there is not currently enough additional yield for the extra risk to go significantly overweight high yield or investment grade.
“It’s now the point where, if you can adjust your positions nimbly when you’re within your sort of trading range that we’re thinking about, then for clients starting off with a 4.8, 4.9 per cent yield out of UK gilts or US treasuries, that’s a reasonable sort of base return for that part of the portfolio, and therefore it justifies a slightly higher weight in the portfolio.”
The manager has been funding the government bond purchases from cash rather than reducing liquid alternatives, which he thinks are going to remain the “bedrock of the diversifying part of the portfolio going forwards”.
He adds: “I think we might see this period where we do see hopefully not sustained positive correlation between traditional bonds and equity but periods where you get through the volatility spikes higher in the correlation between traditional bonds and equity, and therefore it’s slightly less useful as a buy and hold diversifier within the portfolio.”
He adds the volatility in bonds since the Liz Truss “mini”-Budget has meant the team has been more active in its approach to selling and buying bonds and using this to their advantage.
Bradshaw adds there are also opportunities in cross-market trading.
She says: “Many of the active managers that we speak with are seeing quite a few opportunities, particularly, you know, as different central banks approach the policy normalisation in different ways and at different speeds, and that has created quite a few opportunities for them.”
When it comes to duration, the overall duration of their fixed income portfolio was in line with the benchmark index, which is comprised of international government bonds as well as gilts, the managers note.
The duration of that index tends to be between six and seven years.
Clark says: “What we tend to find is that a lot of the managers we’re investing in are not necessarily going out a long way on the curve, but they’re thinking more of the opportunities around the shorter end or the mid-point of the curve, rather than really looking to exploit those opportunities.”
Although he notes there were “some very attractive opportunities” further out in the gilt curve.
“But for us, when we’re running the overall portfolios, that again, that comes with quite big price swings, and we’ve got to think about the capital element of our clients’ investments as well.
“And that’s why we tended to keep the exposure more, sort of, around the benchmark area.”
Carmen Reichman is multi-media editor at FT Adviser