Posted on: 15 April 2016
Fixed interest markets have traditionally been the safe haven for risk-averse investors, offering sanctuary from the volatility that can rage in equity markets. Conventional wisdom dictates that when riskier assets, like shares, fall in value, the price of bonds usually rise.
But bonds haven’t exactly behaved according to this convention recently. When equities have fallen, so have bonds – they have been moving in the same direction, defying the norm. This isn’t what investors have become accustomed to. The question is whether this is the new reality.
Slow and steady
The characteristics of fixed interest asset classes do vary wildly, but generally speaking, bonds are used to provide a steady income and form the defensive part of an investor’s portfolio. Why? Well, it’s because the ‘fixed’ return in the form of interest that bonds provide is known beforehand, and as long as a company or government remain credit worthy, that return will be honoured. So bonds are – generally speaking – much less volatile than equities, which can see their dividends cut, as we have seen with some of the mining companies recently.
The most low risk bonds are issued by governments, such as those issued by the UK government which are called ‘gilts’. Obviously, some government bonds hit a blip during the sovereign debt crisis and you’d have to be a brave investor to buy Greek bonds, but generally speaking, the risk of default on a sovereign bond investment is very low.
Not the norm
Recently, the relationship between bonds and equities has changed as they’ve increasingly moved in the same direction.
Expert opinion is still divided as to why, but it might well be the lingering effects of the global financial crisis, the low inflation environment or the extraordinary monetary policies deployed by central banks since the crisis. Quantitative Easing (QE) has been used by a number of central banks and has distorted the normal functioning of bond markets.
At Duncan Lawrie, the uncertainty of the direction of economic growth, combined with the increasingly erratic behaviour of central banks leads us to conclude that the future performance of bonds is anything but certain. In this environment, in the short term, we think it makes sense to selectbond fundsthat have the flexibility to invest across a range of different fixed interest markets and change their positioning as events unfold, increasing diversification and improving the chances of the fund manager delivering a reasonable return.
But whilst fixed interest markets are wobbling and bonds are acting out of character at the moment, we are confident that in the medium to long term, the traditional relationship between equities and bonds will start to re-establish itself. Bonds – we are sure - will at some point return to being the much more predictable asset class we know and love.
All data has been compiled by Duncan Lawrie from sources believed to be reliable. Full details of sources are available on request.
The comments and figures in this document are generally applicable but you should always take specific advice to suit your individual circumstances before taking any action. Errors and omissions excepted.
The value of investments and income generated may fall as well as rise, and investors may not get back the amount invested. Past performance is not a reliable indicator of future results.