A feature of markets in recent years has been the steep rise in yields offered on gilts and US Treasuries.
There has been some pull back, with the 10-year UK government bond presently (February 28) being above 4 per cent.
As the prevailing rate of inflation falls, certain parts of the government bond market now offer a yield that compares with inflation or surpasses it.
In such an environment, does a client need to worry about being diversified when it comes to fixed income?
Craig Inches is head of rates and cash at Royal London, and says the key to diversification may be around the duration of the bond exposure rather than the type of bond.
He says the yields on short-term bonds are presently such that even a material fall in yields would still mean they offer a better return than cash.
Inches adds that longer-duration government bonds are now at a level of yield that, even if bond prices fall from here – bond prices falling sends yields higher – the current yield may be high enough that it offers a cushion for any capital losses that occur along the way, that is, the income collected could be enough to see an investor in profit overall.
Nicola Mai, an economist at Pimco, says: “While fixed income markets have the potential to weather multiple macroeconomic outcomes, an active and flexible strategy, able to tactically adjust positioning, can potentially generate strong risk-adjusted returns with a steady income stream in an array of economic environments.”
David Roberts, bond fund manager at Nedgroup, says the landscape for bond investors will be radically different in the coming years, the determinant of returns being more likely individual bond selection than the duration, which has powered returns to date.
Duration is the measure of the impact that movements in the base rate have on the price of a bond.
Roberts says he believes that the era of very low interest rates and bond buying by central banks created fixed income markets where the only thing an investor had to get right was duration, by being either short or long, as individual bond selection was made irrelevant.
In that environment, an investor who was able to understand the drivers behind inflation and rates could make money, almost regardless of the bonds they bought, but Roberts says that as those policies unwind, markets will change.
Time marches on
Frédéric Taché, head of fixed income at St James's Place, told FT Adviser that in general they prefer to see fund managers focused on getting duration right, rather than taking extra credit risk.
But he says the key lesson from 2023 was that bond markets were mostly in negative territory, until the final quarter, when a sharp shift in rate expectations caused a rally in bond markets and many portfolios ended the year in profit.
