Bond yields move inversely to bond prices
Richard Carter, head of fixed income research at Quilter, says: “The principal role in a balanced portfolio is to provide diversification. In a balanced portfolio we would typically have 15-20 per cent in bonds, and the balanced portfolio would be the majority of our clients.
"For the more cautious client, we would perhaps have 40 per cent in bonds. To be honest, right now there is a case for having cash rather than bonds – we have high levels of cash in some portfolios.”
Despite slowing economic growth rates, investors are shunning bonds, according to Rupert Thompson, chief investment officer at Kingswood. The big risk that everyone is worried about in markets right now is inflation, he says, and high inflation is very bad for bonds, so they cannot play their traditional role as protector against equity market risk.
This is because the spending power from the fixed income of a bond is diminished by the rising prices that are the result of inflation.
Jeff Keen, head of fixed income at Waverton, says he has been “very negative” on bonds for a very long time, due to higher inflation and concerns around valuation.
Thompson says the market has been “taken by surprise” at how quickly interest rates are rising, “and now we need some clarity on when policy will stabilise”.
While many market participants are concerned about recession, Thompson says: “While economic growth is slowing, it is slowing from a high starting point. There will come a time when people view the main threat to portfolios as being from recession, rather than inflation, but we are not at that point yet.”
Keen adds: “The market is forward looking, so owning long-dated government bonds now is prudent, as, in time, the focus will switch to worries about slowing growth, and that will lead to government bonds performing strongly.”
Carter’s view is that “if we start to see recession coming down the line, then bonds become worth a conversation. The area that is of most interest right now is high yield. Because the economy is growing, companies should be able to pay their debts while the higher income from those bonds offers more protection from inflation.”
Tim Foster, who jointly runs the £800m Strategic Bond fund at Fidelity, admits that inflation is “toxic” for bond investors, but says the recent sell-off in government bonds actually means they can revert to their pre-global financial crisis status as diversifiers if a recession happens. While equities and bonds have both fallen this year, government bonds have fallen much farther, and would be expected to rise in the event of an economic downturn, while equities would fall further.
