Investors in supposedly low-risk multi-asset funds may be sleepwalking towards losses due to “toxic” levels of gilt exposure, advisers have warned.
Advisers have claimed many cautious multi-asset investors have been left highly exposed to the UK government bond (gilt) market without understanding the potential volatility and losses they could face.
Data from Morningstar, via Lakewood Portfolio Management, showed more than 25 multi-asset funds, scattered through the Investment Association’s Mixed Investment and Unclassified sectors, had more than 20 per cent in gilts, while nine funds had more than 30 per cent.
Gilts have historically played pivotal roles in cautious portfolios as low-risk core holdings, but some experts consider the asset class currently carries substantially higher risks in terms of volatility and the amount of capital investors could lose.
Scott Gallacher, a director at IFA Rowley Turton, said investors were buying gilts in order to get slightly better returns than from cash, but were taking on “hugely more risk for virtually no reward” given the low yields now on offer on gilts compared to cash.
With the risks in gilts increasing, Mr Gallacher said managing portfolios for older, cautious clients was currently the “hardest job” to do and was a potentially huge problem with the upcoming pensions freedoms set to give a large number of retirees control of their pension pots.
Andrew Alexander, director and head of investments at Lakewood, said gilts on their current valuations were “toxic assets”.
He said the prevalence of the asset class in cautious funds, which often top sales charts, was a concern because “most investors who have this inflated exposure to such a toxic asset are cautious and therefore have capital preservation as the foremost investment mandate”.
But he said these investors could instead face unforeseen risks, if sentiment towards gilts turned and “everyone heads to the exit at the same time”.
Gilts rallied significantly at the start of 2014, with the asset class being one of the best performing during the entire year. But that has pushed yields, which move inversely to gilt prices, to record lows.
And volatility has begun to pick up. In January this year, the FTSE Actuaries UK Conventional Gilts All Stocks index, a major benchmark tracking the value of UK government bonds, rose by 4.6 per cent.
But since the end of the month the index has fallen by 5.4 per cent, data from FE Analytics showed.
Such volatility has historically not been associated with gilts.
According to data from FE, the annualised volatility of the gilt index in the past six months was 10.6 per cent. This was not only nearly double the 5.7 per cent volatility measured in the past 10 years, but was also higher than the volatility on the FTSE 100 index, which was 9.9 per cent in the past six months.
Aurora Financial Planning’s Aj Somal said it was “a concern that gilts are making up such a large proportion of cautious or defensive funds”.
“It is doubtful that all investors are really aware of the risks they are taking on by having such a large exposure in this area,” he said.
Cautious funds have ‘never been more risky’
Cautious multi-asset funds “have never been more risky”, according to Psigma Investment Management’s chief investment officer, Tom Becket.
Mr Becket said the issues all stem from record low bond yields brought about by central bankers’ financial repression.
“Cautious portfolios have now never been more risky because they are all linked to the same trade, which is low and falling government bond yields,” he said.
Mr Becket explained this trade did not just affect gilts, but also investment-grade bonds and other assets whose valuations have been supercharged in the hunt for yield, such as real estate investment trusts and high-yielding equities.
Momentum signals gilts are a ‘sell’
It is time to sell your gilt holdings, according to iFunds’ investment manager Stacey Ash, as price momentum turns against the asset class.
The iFunds Spectrum range, which is run using a momentum-driven metric, maintained a large weighting to gilts throughout 2014 and into 2015. In fact, two of the funds had more than 30 per cent in the asset class at the end of January.
But following the sharp sell-off in gilts in February, Mr Ash said the team had completely sold out of the asset class.
The decision was made because the manager follows a quantitative process that allows investment only in assets with the best momentum metrics.
