In the past, before extraordinary monetary policy became a mainstay
of central bank decisions across the world, holding bonds in
your portfolio was a popular way of investing.

Some government bond yields across Europe have moved into negative territory due to asset purchases by the European Central Bank as prices (which move inversely to yields) hit record highs.

And investors looking for material income from this asset class in the UK will be sorely disappointed. David Roberts, global head of fixed income at Liontrust, says ‘would I lend money to the UK government for 10 years for 1.25%? not a chance’.

UK government bonds or gilts are the most easily accessible government debt instrument available to UK investors.

However, there are a plethora of reasons why they might not be the best type of bonds to hold in this part of the economic cycle. Paul Jackson, head of multi-asset research at Invesco says there was a time when he was saying that the UK looked the most interesting government bond because he thought yields would go up in line with rising interest rates.

‘My concern is that Brexit limits how much the Bank of England can tighten if at all,’ Jackson says. ‘The weakening of the economy would bring down gilt yields, therefore I don’t see much interest because in real terms looking at the inflation linked index you’re getting a sizeable negative yield’.

He adds that if he was 25 years old he would stay away from gilts due to the lack of returns, although as someone gets older the asset class’ use for diversification becomes more interesting.

A DIVERSIFICATION TOOL

Holding high grade bonds, either highly rated sovereign bonds or triple A investment grade bonds issued by companies can be a means of diversifying a portfolio.

James de Bunsen, a portfolio manager at Janus Henderson, makes the point that diversification is very valuable but only applies to government bonds and to some investment grade. He adds that riskier bonds act more like equities.

For yield starved investors looking for income they offer the prospect of higher yields but at the cost of going significantly up the risk spectrum.

Although bondholders are ahead of shareholders in the queue if a company goes bust, it could still default on its bond payments or coupon.

He adds retail investors should stick to sovereign bonds with the main risk to understand being the direction of interest rates.  Once used to these assets, they may want to want to move into areas such emerging market bonds with higher yields ‘where you get real returns’.

Another option in the bond space is retail bonds, which are available via the London Stock Exchange’s ORB platform.

USING BOND FUNDS

Holding one or two retail bonds is not going to provide much diversification, so it may be more prudent to invest in a bond fund. Ben Edwards manages both the BlackRock Corporate Bond Fund (GB0003749982) as well as the firm’s Sterling Strategic Bond Fund (GB00BZ6DDJ74).

Edwards likes to invest in the triple BBB and double BB rated corporate bond space as this can offer the most upside. This is where it really makes sense to pay for professional expertise as there are plenty of risks to navigate.

Triple-B and double-B is the link between the lowest type of investment grade and the highest part of high yield or ‘junk’ bonds.

For Edwards, these classifications are ‘arbitrary’. 
If I looked at the double B space in sterling most people would not be worried about these companies, the Tescos, the Sainsburys, the Jaguar Land Rover of this world. These aren’t in investment grade indices.’

However, Edwards adds that the bond market valuations have been quite rich recently so he has moved into government bonds waiting for corporate bonds to become cheaper. It’s similar to managers moving into cash when equities have become expensive as both
are low-risk places to park your money.

BONDS AROUND THE WORLD

With many managers bemoaning the state of the UK gilts at the moment, where is a good place for an investor looking for government bonds to go hunting? The US is highlighted by a couple of managers as US Treasuries yields have picked up of late.

John Stopford, a multi-asset manager at Investec, thinks Australian state bonds offer attractive yields at decent prices although concedes these are difficult for UK retail investors
to access.

His conclusion seems apt, ‘people aren’t going to lose a lot of money holding bonds but aren’t going to make a great deal either’. (DS) 

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