Coping with a bubble in bonds
Investors have flocked to bond funds in recent months, but are bond markets now overbought?
Retail investors have continued to flock into bond funds in recent months as the global economic situation remains uncertain.
More than £4bn of UK investors’ money was shifted into the funds overall in the first quarter of 2012 alone, according to Morningstar.
This tide of net inflows has arrived as bond markets have been viewed as a ‘safer’ alternative to equities, which have proved extremely volatile as issues such as the eurozone sovereign debt crisis have triggered alarming headlines.
In particular, the IMA UK All Companies sector of funds that invest in growth-focused UK equities saw £1.14bn of investor withdrawals in total in the first quarter, Morningstar adds, the biggest net outflow of any sector.
As money has flowed out of equities and into bonds, certain fixed income markets have started to appear expensively valued
However, as money has flowed out of equities and into bonds, certain fixed income markets have started to appear expensively valued.
In the government bond markets of the US, UK and Germany, which are often seen as ‘safe haven’ alternatives to more troubled areas, investors have now piled in to such an extent that they are being forced to accept the lowest levels of income yield ever reported on the markets.
At the same time murmurs of the high yield bond market looking to be in ‘bubble’ territory, with prices rising to fresh highs in recent months, refuse to go away.
The extent of this tidal shift into bonds raises a question that investors are now having to face up to – are the markets overbought? Are they now simply too expensive?
Experts warn that investors should now be considering other areas, with equity funds that focus on companies that return high levels of dividend income at the top of the list.
Equity income ‘a better alternative’
Ben Seager-Scott, senior analyst at Bestinvest, says that, relative to government bonds in particular, some equity income funds are offering “quite compelling” levels of income with potential growth prospects in the very long term.
“In the medium to long term, we expect a sell-off [in government bonds], but the timing is difficult to call,” he adds.
Matthew Rubin, senior vice president and director of investment strategy at Neuberger Berman, agrees: “We are definitely more constructive on equities relative to fixed income. We think that yields in most of the fixed income markets today are going to be very, very weak given where we are in the interest-rate cycle.”
Mr Rubin adds that there is more risk associated with the bond markets today than investors appear to anticipate.
He says: “A bubble is being inflated, it has been inflated and investors should be thinking about other places to find yield and income outside of traditional fixed income.”