Caution in the Bond Market

Across the wide range of bond markets, yields are close to all-time lows.  Indeed, in continental Europe bond yields are the lowest in some 500 years

Nutmeg 10 September, 2014 | 11:12AM

This article is part of Morningstar's "Perspectives" series, written by third-party contributors. Here, in a piece for Morningstar's Guide Financial Education, Shaun Port, Nutmeg’s CIO explains why they have taken a cautious stance on bonds.

Fixed income securities, commonly known as bonds, are generally regarded as safer investments than company stocks.  Bonds come in many flavours, such as safe bonds, like those issued by the UK government, and much riskier bonds, like those issued by companies with a poor credit record, known as ‘junk’ or ‘high-yield’ bonds, or by countries with a less than perfect record of making repayments – Argentina is a current example.

The values of bonds are largely based on two factors: the time to maturity – that is, the time until the face value of the bond is paid back – and the likelihood, however small, that the borrower will default on payments.  Because bonds normally pay a fixed rate of interest on the face value, one of the biggest threats to holding a bond for a long period is the rate of inflation – in other words, how much today’s pound will be worth in the future: even at just 2% inflation, £100 today will only be worth £82 in 10 years.

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