What are the dangers for fixed income in 2013?

Darius McDermott, managing director of Chelsea Financial Services

“Fixed income has experienced a phenomenal rally in the past couple of years, but I don’t think this is sustainable. Investors will need to set their sights lower in future.

“Gilts continue to worry. They once offered risk-free returns, now they offer return-free risks. They are giving next to nothing in terms of current yield on 10-year bonds. A small rise in interest rates would lead to a big capital loss on the gilt index. Investment grade and high yield bonds are slightly better with pockets of value in BBB but stockpicking will be key. The UK and European high yield bond markets are still relatively small so may struggle to meet demand should investors continue up the risk scale in search of yield.

“I still think strategic bond funds are the best bet because of their flexibility and ability to manage interest rate and credit risks.”

Ben Seager-Scott, senior research analyst at Bestinvest

“I think the biggest danger for fixed income is a rising interest rate environment, which would push up bond yields hammering capital values, especially for government bonds. We have seen strategic bond fund managers reduce their duration, which determines their sensitivity to interest rate changes, but many investors in plain vanilla quality bond funds will still have quite long duration exposures. There is a lot of demand for income, and with longer duration comes higher yield, but investors risk leaving themselves more sensitive to interest rate changes.”

Chris Mayo, investment director at Wells Capital Investment Solutions

“The biggest danger to fixed income will be the rotation of money, which could have liquidity issues for fixed income managers. Given the strong run government and investment grade bonds have had in the past three years, many bonds are offering negative real yields and for clients their incomes are falling. Investors will begin to take profits and join those coming out of cash. Growth prospects by buying into lower quality corporate bonds, high yield and equity income funds will be compensated for taking on this additional risk.”

Adrian Lowcock, senior investment manager at Hargreaves Lansdown

“A change in interest expectations in the UK or US could cause bond yields to rise. If growth continues to recover in the US we could see the outlook change for the US to raise rates sooner rather than later. While it remains unlikely that they will do this in 2013 the change in outlook would probably be enough to cause rates on bonds to move. This will have an effect on corporate bonds as they are sensitive to interest rate movements and, given they are at 0.5 per cent can only go one way. The UK could lose its prized AAA credit rating as it struggles to keep the economy out of recession. This could result in gilt and corporate bond yields rising, and prices falling. However when the US lost it’s rating it had very little impact. The UK government has roughly £350bn in government treasuries which it could put on the market. Such a large sum would cause prices to move significantly. Likewise stopping quantitative easing would also affect the bond market and cause yields to rise.”

Ben Willis, investment manager and head of research at Whitechurch Securities

“Inflationary concerns: this may not materialise in 2013, but inflation proofing your portfolio is definitely something to consider this year. As we have seen, the Bank of England (BoE) has not managed to accurately achieve inflation targeting for the past five years. Furthermore, the Fed, Europe and Japan have all indicated that inflation targeting may have to be reviewed. This has also been mentioned by the forthcoming governor of the BoE, Mark Carney, who has hinted about linking it to nominal GDP. The central bankers all want inflation to reduce their debt burdens.”