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Natixis: Advisers face more risks by selling bonds

Natixis: Advisers face more risks by selling bonds

Selling your clients’ government bond holdings could risk shifting them out of the frying pan and into the fire in spite of dizzying valuations on credit markets, an investment group has warned.

Investment Adviser recently reported that many ‘cautiously managed’ mixed-asset funds had a precariously high weighting in sovereign debt – a potentially “toxic asset”, according to Lakewood’s Andrew Alexander, which looks vulnerable to a reversal in central bank policy.

Now a survey of advisers by Natixis Global Asset Management has pointed to advisers selling down their clients’ government bond stakes and shifting them into other areas such as riskier high-yield bonds.

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Natixis said this could lead to a concentration of equity-like risk in clients’ portfolios.

James Beaumont, head of the portfolio research & consulting group at Natixis, said: “Many of the replacement asset classes chosen are actually more correlated to equities, and therefore reduce overall levels of diversification in portfolios.”

US and UK government bonds were two of the best performing assets during 2014, delivering high returns with low risk as yields, which move inversely to price, consistently fell.

At the end of January, yields on 10-year US and UK government bonds hit all-time record lows, pushing prices up further and reflecting the extreme levels of demand.

The bonds have fallen in value since, prompting experts to warn government bond investors could be facing negative returns in the coming years.

The 126 adviser portfolios analysed by Natixis showed strong performance on average in the past three years, with the average conservative portfolio beating the performance of the FTSE WMA Stock Market Conservative index, and with less risk.

But in meetings with Natixis in the final quarter of 2014, advisers said one of their biggest fears was an impending rise in interest rates, so they had been selling out of government bonds.

Mr Beaumont said that while the returns on adviser portfolios were strong in the three years measured by Natixis, the move out of government bonds into more equity-like assets meant “this lack of diversification may well prove costly in the event of a severe market correction”.

High-yield bond funds have historically been correlated to equity markets, whereas government bonds are negatively correlated.

This means that during previous equity market crashes, government bonds would have made money for investors, while high-yield bonds were sold off in the same way as equities.

Natixis said therefore that by abandoning government bonds, advisers’ clients would not have enough negatively correlated assets to properly withstand an equity sell-off.

This need for diversification was a key theme in Natixis’ survey, which also highlighted the need for more diversification into alternative assets within aggressive portfolios.

The study found that 85 per cent of an average adviser’s aggressive portfolio contained equities while just 6 per cent was in alternative assets, such as property or gold.

Natixis said this meant advisers were pinning their diversification hopes on equity markets being uncorrelated to each other which, with the exception of Japan and India, had not been the case in recent history.