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US Government Bonds Should Outperform UK Gilts

Morningstar Investment Management's Head of Capital Markets Tanguy de Lauzon explains why he has increased exposure to the US yield curve in recent months

Tanguy De Lauzon 27 April, 2018 | 2:28PM

 

 

Tanguy de Lauzon: US Treasuries are starting to look exciting for the first time in over a decade. The US 10-year yield has now doubled since its lows mid-2016 and is getting close to 3%. This compares to a 1.5% yield in the UK. Whether we look at nominal yields or real yields that is adjusted for inflation expectations, this spread is at levels we've rarely seen in history.

From a portfolio construction perspective, a key role for bonds is to provide diversification, in particular in periods of equity market turmoil.

With this in mind, our preference is to consider US Treasuries with a hedge on the US dollar to preserve the defensive characteristics of this asset class.

Now, hedging a US dollar exposure currently comes at a pretty high cost of about 1.6%, which effectively offsets the yield differential between the US and the UK. Despite this, our research has shown that there is currently a good probability that an investment in US Treasuries will outperform an equivalent investment in Gilts over the medium to long term. 

Moreover, with US yields starting from a higher level, we have confidence that the protection potential of US Treasuries would likely be at least a good, as that of Gilts.

So while we keep large part of our bonds exposure in the UK, we have significantly increased our exposure to the US yield curve in the recent months, and believe this will lead to better outcomes from both a risk and a return perspective.

 

The information contained within is for educational and informational purposes ONLY. It is not intended nor should it be considered an invitation or inducement to buy or sell a security or securities noted within nor should it be viewed as a communication intended to persuade or incite you to buy or sell security or securities noted within. Any commentary provided is the opinion of the author and should not be considered a personalised recommendation. The information contained within should not be a person's sole basis for making an investment decision. Please contact your financial professional before making an investment decision.

About Author

Tanguy De Lauzon  is Head of Capital Markets & Asset Allocation for Morningstar Investment Management EMEA

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