UK government bonds recorded their worst annual performance since the turn of the century last year as yields rose on the back of improving UK economic data and the prospect of an end to quantitative easing in the US.
The FTSE British Government All Stocks index lost 3.9 per cent and funds in the IMA UK Gilts sector lost an average 5.1 per cent in 2013, according to FE Analytics.
And Axa Investment Managers’ fixed income chief investment officer Chris Iggo forecast UK gilts to be “the worst performer” in 2014 “because of the long duration notion of the UK market”.
“Strong UK data will test the Bank of England’s monetary stance and yields will be sensitive to this,” Mr Iggo said.
But lower-risk model portfolios and risk-targeted funds are still forced to hold UK government bonds in spite of the poor outlook for the asset class as they are traditionally used to reduce a portfolio’s volatility and provide diversification from equities.
Multi-asset fund managers are urging investors to take the ‘counterintuitive’ option and reduce their exposure to gilts and US Treasury bonds. Nathan Sweeney, investment manager at Architas, said: “Government bonds are perceived to be less risky and you want to have portfolio insurance against the probability of a market setback.
“This is prudent, but it is outweighed now by growth returning in the UK and US – you’re likely to lose money in UK and US government bonds.
“It’s counterintuitive, but at certain points in the cycle you have to be [out of gilts] because you’re going to lose money.”
Mr Sweeney added that improvements in economic data will lead to government bond yields – which move inversely to prices – being “a lot higher” in the months ahead.
Darwin Investment Managers founder David Jane said: “Irrespective of the risk in that asset class, if you force investors to hold an asset even if it’s going to lose money it’s irrational. You are dooming yourself to make avoidable errors as there are times when you don’t want that exposure.”
James Klempster, portfolio manager at Momentum Global Investment Management, said investors who are forced to hold gilts “should be considering trimming their duration” in order to reduce sensitivity to movements in interest rates.
But Premier’s David Hambidge – whose multi-asset team runs six volatility-targeted funds – argued that gilts will still give investors “a relatively smooth ride”, even if they do lose money.
“You’re not going to lose your shirt in gilts,” he said. “They are being likened to overvalued tech stocks, but they are not. You are getting paid 3 per cent a year on a 10-year gilt.
“I still argue it would do a job in all sorts of portfolios.”
The bond manager’s view
Pimco’s Mike Amey, head of sterling portfolio management and manager of the Allianz Gilt Yield fund, said investors “absolutely should not lose sight of the fact that bond yields are going to go higher”, meaning prices will fall.
“The question is how quickly this will happen,” he said. “The market is overestimating when interest rates will go up. It expects it by 2015, but we think that is hard to see.”
Mr Amey highlighted five-year gilts as looking “good value”.
