Bond Funds for Interest Rate Uncertainty

Yesterday the Bank of England surprised markets by choosing to keep rates at 0.5% - what are the options for bond investors in these uncertain times?

Emma Wall 15 July, 2016 | 1:20PM
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Emma Wall: Hello, and welcome to the Morningstar series, "Ask the Expert." I'm Emma Wall and I'm joined today by Ashis Dash, Fund Analyst for Morningstar, to talk about bonds.

Hi, Ashis.

Ashis Dash: Hi, Emma.

Wall: So, yesterday we had the expectation that Bank of England was going to cut rates to 0.25%, but it didn't do that, did it?

Dash: No. Against widespread market expectations, the Bank of England actually held rates at 0.5% and this was predominantly driven by the lack of any official economic data post the Brexit referendum. The bank has, however, reiterated that the path of growth from hereon could be affected by Brexit and then it could also push up inflation because of the currency depreciation. But they have committed to doing whatever it takes to maintain or support growth and then get the inflation to about 2% target that they have.

Wall: This, of course, means that although they didn't cut rates yesterday, there may be rate cuts down the road?

Dash: Yes, they didn't mention that it could happen in August. The form of it is, however, still debatable. It could be a rate cut; it could be further stimulus; or it could be more quantitative easing; or it will be a combination of these.

Wall: Of course, even if there's not a rate cut, rates, of course, remain at record low levels here in the U.K., 0.5% for seven years. It's never been that low before. And indeed, across the western worlds we have seen very low rates. The Fed were expected to raise rates about four times in 2016; they've held tight. And in Europe, there's negative yields, aren't there?

Dash: Yes, that's true. We did see Fed hiking rates in December last year and then there were expectations of more hikes this year, but none of that has materialized yet. In Europe also, ECB and Japan, both have cut rates and they are in negative territory as of now. In the U.K. there was expectation of rate increases but Brexit has changed. But there are places such as some of the emerging market economies where we have seen rates being hiked, so examples would be Venezuela and Mexico.

Wall: And of course, that means there is yield available for people who want to invest in bonds because it's still an important part of a diversified portfolio?

Dash: Yes, as you mentioned, there is yield available. In such an environment where you have yields at historical lows, you have a couple of options as fixed income investors. Some of them might be taking on more risks, so you can take on more credit risk, the likes of more high-yield bond funds or you can go into flexible bond funds focusing on high-yield and the other way would be going into emerging markets which are still offering reasonable yields and we have spoken about this earlier.

Another point worth noting would be funds like the M&G Global Macro Bond Fund, so the global macro bond space where people or managers would invest into currencies as well, so they can take long and short positions in currencies on top of the traditional credit and rates parts of the spectrum. So, it basically gives you an additional driver for generating returns.

Another strategy that I think could work here would be the strategy, the relative value strategies by Michael Krautzberger and Team at Blackrock. They basically play a relative value strategy against two bonds. So they will play the differential between a cheap and an expensive bond instead of taking a bet on the direction of the market. So, I think that could be another strategy which could be considered here. The long-only fund is called the BGF Euro Bond Fund and the long-short version is the BSF Fixed Income Strategies Fund.

Wall: Ashis, thank you very much.

Dash: Thank you, Emma.

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
Rating
BGF Euro Bond A227.59 EUR0.29Rating
BSF Fixed Income Strategies A2 EUR120.33 EUR0.17Rating
M&G Global Macro Bond GBP R Acc140.34 GBP-0.53Rating

About Author

Emma Wall  is former Senior International Editor for Morningstar