7th May 2015
Given that bond prices in the UK, US and Germany have fallen dramatically, as a rising oil price has fuelled speculation interest rates may rise sooner rather than later, fixed income investors may need to take cover.
The yield on the 10-year benchmark UK gilt now stands at 1.98%, almost 50% higher than on 30 January when it fell as low as 1.33%.
Laith Khalaf, senior analyst at Hargreaves Lansdown said: “This example highlights the perils of investing in bonds at such very low yields. Indeed, yields are still very low; at 1.98% the 10 year gilt is still yielding half as much as it was five years ago.
“The recent fall in gilt prices is a warning shot to bond investors. Even though yields are still exceptionally low, they aren’t as low as they were, and that has taken its toll on capital invested at the wrong time.”
Laith urged that the sell-off is a reminder of the risk of investing in bonds at such low yields.
“This is heightened by the fact government bonds are seen as safe investments, and consequently feature in many pension funds and supposedly low-risk portfolios,” he added.
Options for bond investors
Right now there does not seem to be much upside for bond investors for the capital risk they are taking, though bonds still offer diversification benefits for investors. Bond investors have done very well in recent years, even when it seemed they couldn’t rise much further.
However where investors wish to invest in bonds Khalaf prefer strategic bond funds, which have the flexibility to invest across the bond spectrum and protect investors from the worst of any sell-off, if the manager gets their calls right of course. Investors might consider Invesco Perpetual Tactical Bond and M&G Optimal Income in this space.
He added: “Investors simply looking for a conservative fund might consider a total return fund like Newton Real Return, where the manager invests across equities, bonds, commodities and currencies, with a focus on capital preservation.”
Alternatively he recommends income-seekers with a long term view might consider a UK Equity Income fund like Artemis Income, which has a current yield of 3.4%, or Threadneedle UK Equity Income, which is at 3.7%.
Khalaf added: “Those who cannot stomach any falls whatsoever in the value of their savings should not be invested in bonds, and should simply hold cash, even though it offers a negligible return.”