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Why are bond funds still popular with investors?

2 years ago

Adrian Lowcock, investment director, Architas

It is understandable that British investors may be a bit more cautious about the future and therefore less willing to take risks.

According to the Investment association November was the sixth month in a row when Bonds were the best-selling asset class, with the Strategic Bond sector taking the lion’s share of £2bn of net inflows.

At first glance, and given the current state of the world markets, this doesn’t make much sense. After more than 30 years of a global bull market in bonds we saw interest rates reach a bottom in the summer of 2016 and since then yields have begun to rise as the global economy began to grow.  The US started raising interest rates and then reversed its quantitative easing programme both of which contributed to low bond yields.

But perhaps we should look at the situation from a UK perspective and indeed the needs of investors. For years after the financial crisis investors were struggling to find a lower risk income as cash rates and then bond yields plummeted, meaning investors had to take on more risk to get a decent income.  The result was investors were being forced into other assets such as equities and in particular defensive growth companies. The term bond proxies became a popular, if inaccurate, description for these companies. With bonds yields recovering from the lows seen in 2016 and back to more reasonable levels investors may have started to switch back into bonds.

The other big factor affecting the UK is Brexit. Whilst forecasts the UK would enter a recession shortly after the referendum weren’t realised, UK growth has been weak in 2017 and political leadership weaker still. Households have also felt the pressure as a weaker pound and recovering oil price has driven inflation above the Bank of England’s 2% target. At the same time household incomes have not risen, reducing people’s disposable incomes.  As such it is understandable that British investors may be a bit more cautious about the future and therefore less willing to take risks.

Add in the fact that we are constantly being reminded that stock markets are expensive perhaps it is not surprising that some investors are turning to bonds at this time. In this environment strategic bonds may make more sense than traditional corporate bond funds as the managers have greater flexibility to move anywhere in the bond universe and use derivatives to deliver a positive return.

However, investors should try to focus on the bigger picture. Yes equities are expensive but after 30 years of a bond bull market, equities look cheap relative to their bond peers.

Inflation in the UK remains high and continues to weigh on the real return investors get from bonds. Fixed income suffers from the eroding effects of inflation as the asset class is not able to raise the yield provided, unlike equities where management can potentially raise prices, profits and the dividend. 

With the global outlook fairly positive the Bank of England have also indicated interest rates are likely to rise further this year and next, again bad news for bonds.

So while bonds have a vital role to play in portfolios this should not mean the potential benefits of equities are dismissed.   

For more information, call us on 020 7562 4900, calls may be recorded.

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