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After the glitter fades

Even when they yielded nothing, or less than nothing, for a prolonged period of time, developed market government bonds found a place in many portfolios as "ballast" - that is as an asset that could dampen volatility at the portfolio level.

That seemed to work rather well for a decade when central banks were buying bonds through QE programmes and the volatility of the asset class was close to zero, while equities delivered the returns

But the events of the past week have cast into question the role of government bonds as hedges against volatility.

We will all have been following the movement of gilt yields this week with a combination of amusement and horror. But in recent days there has also been a deep sell off in Treasuries.

This may be because the Japanese central bank, determined not to allow its currency (which has performed almost as poorly against the dollar as sterling) to weaken further - and so has been selling its stock of Treasuries.

Gilts rallied at the very long end of the curve on Wednesday as a result of the Bank of England effectively restarting QE, but that bond-buying programme is focused for now on the long end of the curve, so it is likely that duration bets will benefit the most. 

The allocators in our database haven't been rushing to buy government debt in recent months, with the average exposure in balanced portfolios falling from 5.2 per cent to 4.5 per cent between the end of May and the end of July, excluding linkers. 

That was a period in which investors' fears of recession increased so it’s notable that, even with bond prices falling during that time, allocators did not, on average, increase exposure to a volatility hedge.

As ever, there are outliers in the data. Invesco had 12 per cent in govies, as part of a chunky total allocation to fixed income of 39.5 per cent. 

Rathbones had more than 11 per cent in govies. Its total bond allocation is 17 per cent, so corporate issuers are very much in the doghouse for the Finsbury Square-based outfit, accounting for just 6 per cent of the balanced portfolio.

The bulk of that 6 per cent is in high yield bonds, indicating short duration is a priority right now. 

As those numbers would suggest, several firms have zero in government debt, including Evelyn Partners and Hawksmoor.

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