Time to test your assumptions about your allocation to bonds? A Mindful Money view

27th June 2013

Do investors face a bond dilemma or not? The answer must be yes. It was the chairman of the Federal Reserve Ben Bernanke who initially caused bond markets to get the jitters when he first mentioned the potential tapering back of quantitative easing later this year and an end to it altogether in 2014.

Back in early May, the world’s most famous investor, the Sage of Omaha himself, Warren Buffett, told CNBC that bonds are currently a “terrible” investment because they are “priced artificially” high as a result of QE and ultimately they could lose investors a lot of money when interest rates start to rise.

Bond markets went into a tailspin on the back of Bernanke’s comments and overall asset prices dropped with equities and even commodities falling though the latter’s drop was exacerbated by concerns about a slowing demand in China.

But while many managers have hastily moved to say that eventually fundamentals, especially in the US, will come to the rescue – and active managers say the climate will help stock pickers, it was the bond markets where most warnings have focused.

One year being mentioned in particular is 1994. Fund managers Ruffer said in a note issued towards the start of this month, that 1994’s events could be repeated when stocks and bonds fell very dramatically. That was a few weeks ago on the back of a miserable May for bonds performance.

Others say that history does not often repeat itself and even in the wake of 1994, when markets went haywire, the US economy saw recovery particularly in stock markets as the International Business Times notes in this piece today.

But it is another warning that caught Mindful Money’s eye this week. This was Hargreaves Lansdown expressing its concerns about so-called lifestyle workplace pension funds which could see big losses for investors if bond yields rise towards more normal levels. These pensions allocate more into bonds and other less risky assets as members near retirement to supposedly protects pension investments as they move closer to maturity. A bias to bonds is more conservative but Hargreaves says in these circumstances losses could get as high as 25 per cent.

Clearly, this is not the scenario investors are facing immediately. Bank of England governor Mervyn King in his last audience with MPs set out his view that interest rates would not be heading back to normal any time soon.

That said, bonds do not look as safe as they normally do. It is something for all investors to think about. It does not mean tearing up your asset allocation or selling out of your holdings and you may be with a multi-asset fund manager or discretionary fund manager who is making a necessary adjustment for you. Such managers are certainly aware of the issue. This is from a note issued earlier this week from Tom Becket CIO at Psigma.

“To be perfectly blunt, it is incredibly difficult to make short term predictions when markets are in a state of panic. However, we believe that we are suitably positioned for the challenges and opportunities ahead. It is also very challenging to make strategy changes when volatility is so high.”

So while Mindful Money is certainly not a suggesting that you embrace market timing, it may be time to test a few assumptions. It is worth having a think about whether you are comfortable about your bond exposure.

As Hargreaves identifies the big risk may be where people are relatively unaware what sort of plan they are in and who may not have much time before they convert it into an annuity income. They might have very little time on their side to recover. But it is something everyone should at least have a view on.

These are not normal times by any stretch of the imagination so it may be wise to test your normal assumptions.

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