Kames Capital’s Stephen Snowden has warned investors flocking to ‘low risk’ bond positions risk missing out on returns as a significant near-term rise in bond yields is unlikely.
The co-manager of the £680.4m Kames Investment Grade Bond fund, said that a yield of 2.9 per cent on UK 10-year government bonds, known as gilts, puts the asset class at reasonable value with base interest rates set to remain low for the foreseeable future.
The 10-year gilt yield has risen considerably from 1.6 per cent earlier this year and, as a rise in yield corresponds to a fall in bond prices, fixed income funds have struggled to generate returns in 2013.
However, Mr Snowden has warned investors not to assume there will be further significant falls in gilt prices and said those taking ultra defensive fixed income positions could miss out on more yield than they gain in capital protection.
He said it will be “a number of years” before interest rates reach 2.9 per cent and even then the new normal is only likely be 3-4 per cent.
Many investors have sought to invest in fixed income funds which focus on bonds with a shorter life span before they mature as these are less sensitive to interest rate movements and so should lose less money if yields rise and bond prices fall.
Given that many experts predict that bond yields are on an upward trajectory, bonds with shorter lives have gained popularity, with several fund launches in recent years focused on bonds with short terms and strategic bond managers increasingly taking positions in bonds with a shorter life.
However, bonds that have a short term to maturity deliver less of a yield than those with a longer life and Mr Snowden warned that investors need to consider the total return they are likely to get.
“If you bet against this market you are betting away income,” he said.
“Every day you are invested in short duration bonds, you get less income and that tortoise creeps up on you. You need price movements to be reasonably rapid to offset the income loss of being short duration.”
In spite of the difficult environment for fixed income, the Kames Investment Grade Bond fund has still made a positive return so far in 2013.
The fund is in the top quartile of the IMA Sterling Corporate Bond sector for one and three years, according to data from FE Analytics.
Mr Snowden said his decision to hold more credit risk than peers – meaning exposure to corporate debt - meant the fund had produced strong returns in 2013.