How to Negotiate Falling Bond Prices

Fixed income investors benefitted from a bond rally lasting more than a decade - but after much warning the tide has turned, with both Gilts and corporate bonds losing cash this year

Emma Wall 2 July, 2015 | 2:12PM
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Emma Wall: Hello and welcome to the Morningstar video, "Ask the Expert." I'm Emma Wall and I'm joined today by Morningstar's Emma Morgan.

Hello Emma.

Emma Morgan: Hello.

Wall: So, we're here today to talk about bonds. For a number of years now people have been calling it bond bubble. They've been worried about when yields finally rise then prices have to fall and this year there has been quite a lot of movement. What so far has happened in the last six months?

Morgan: Yeah, Emma, it's certainly been a really interesting time. So, I don't know if you remember, but if we cast our minds back to the beginning of the year, we had concerns like deflation, we had slowing economic growth and we also had the ECB's announcement on QE. That led to a significant rally in government bond markets.

And then when in April we saw bond yields got down, the 10-year bond yield got down to as low as 10 basis points, a quarter of the market was on negative yields in Europe. But since then we've seen a sharp sell-off, mainly for technical reasons, but investors have been really surprised at the extent and speed of the sell-off in government bond markets and we see now the 10-year bond yield in Germany is at around 80 basis points today.

Wall: It's quite interesting really because it seemed for ages people were saying bond prices are going to go down, bond prices are going to go down and they kept going up and they kept going up. But now you say there has been this reversal. What does it mean for investors?

Morgan: Well, we've just had six months numbers out for investors. So, for U.K. investors invested in gilt bonds, they have lost about 2%, so that's been the worst performing part of the market. Corporate bonds, which are more correlated to government bonds, have lost about 1% and the best area of the market has been high yield, that's up about 2%. But obviously, those numbers mask the volatility we saw over the last six months.

And with the Fed likely to hike rates in September, maybe December, U.K. looks like they are likely to also hike rates in around March or maybe Q2 next year. But against that the ECB continuing with their QE program we are likely to see continuing volatility in the market.

Wall: And that all leaves bond managers in quite a sticky situation because you have got seemingly yields coming out, prices going down in and a major sway that the environment and you've got all this QE from both Europe and Japan. I mean, where can they find opportunities?

Morgan: Yeah, it's definitely been a challenging environment for bond managers and in terms of the duration positioning, we are not seeing many make significant calls. Most are probably neutral to slightly short; but given the sell-off we've seen, they are probably looking to add back a little bit of duration at this point. The other areas of markets are continuing to find some selective opportunities are within high yield and financials.

Wall: Because of course even if bond yields are going up and prices going down fixed income is still an important diversifier for a number of investors, both private and professional and so, it is important to have a position within your portfolio to hedge against what's going on with equities. With that in mind, perhaps you could name a couple of bond funds that you think do well in this sort of environment.

Morgan: Sure. So, for investors that are looking for corporate bond fund that have a long-term investment horizon but are perhaps concerned about interest rate hikes, we think the Invesco Perpetual Corporate Bond Fund is an interesting fund. So, we like the manager's long-term approach. They are quite value-orientated and they are willing to back their views with high conviction. So, at the moment, they are quite defensive. They have been concerned about the value within the market. So, they have considerable positions in government bonds and cash. They have a very low duration position. So, it's around four years which is about half that of the corporate bond market and they are selectively finding opportunities in subordinated financials.

For those investors that do have an allocation to fixed income but don't know where to allocate to an interesting option could be the Fidelity Strategic Bond Fund. So, this manager can allocate to high yield, to government bond and to investment-grade and he will dynamically allocate across those parts of the market. At the moment, he probably has about 30% in high yield, about 20% in government bonds and the rest in investment-grade. We really like the manager's top-down macroeconomic analysis and also his sensible approach to portfolio construction.

Wall: Emma, thank you very much.

Morgan: Thank you.

Wall: This is Emma Wall for Morningstar. Thank you for watching.

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.

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Securities Mentioned in Article

Security NamePriceChange (%)Morningstar
Fidelity Strategic Bond27.63 GBP0.22Rating
Invesco Corporate Bond UK Acc216.67 GBP0.24Rating

About Author

Emma Wall  is former Senior International Editor for Morningstar

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