19th June 2015
The era of consistently falling bond yields is over and we are now more likely in a rising trend, Miton multi-asset manager David Jane has said.
The ‘lower for longer’ era driven by quantitative easing (QE), declining inflation and demographics in the developed world is at an end believes Jane, co-manager of Miton’s multo-asset fund range,
Jane said these factors have had a ‘number of consequential effects beyond government bond markets, in fact right across the investment spectrum’ and up until early February his portfolios have a strong long-duration bias which has subsequently been reversed.
‘This involved selling our long dated government bonds initially to cash and latterly we have also been holding some short dated high yield credit and emerging market debt,’ he said.
He said the reversal in volatility has coincided with a change of direction generally.
‘It seems clear that the era of ever falling bond yields, is now behind us and we are now at best in a sideways range and more likely in a rising trend,’ said Jane.
‘If this is the case we need to revise not only our view within fixed income but also need to consider whether some of the trends in other asset classes which have been driven by this powerful force are also set to reverse.
‘Within fixed income the power of the search for yield has driven credit spreads consistently lower as government yields have fallen, defying conventional wisdom that there is an inverse relationship between spreads and yield. The market in practice has done quite the opposite. As yields have fallen, the relative attractiveness of corporate spreads has increased as investors have sought to replace the lost income. In addition, expected credit losses have declined, reflecting the reduced burden of interest payments.’
He said a similar effect can be seen in equities, which has gone against conventional wisdom.
‘Theory would suggest that falling bond yields benefit high growth stocks, where the effect of a reduced discount rate has a disproportionate effect on the valuation, versus ‘short duration’ stocks such as tobacco where current earnings and distributions are a higher part of the perceived value,’ he said.
‘Again, in practice, the exact opposite has occurred – ‘bond proxies’ with high current yields have been the big beneficiaries of QE as investors have attempted to replace lost income from deposits and government bonds with dividend yields from equity.
‘So much for investment text books and market theory, understanding investor behaviour is greatly more important than academic theory.’
Looking further into the future, Jane said he believes the risk in bond markets is to the downside.
‘Yield can only fall so far from here and yet can rise materially, so even if we are wrong that the long term trend is now higher, the downside is limited,’ he said.