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Bonds keep appeal to minimise risk

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Understanding drivers of change

Bonds keep appeal to minimise risk

Markets across the globe are poised for hikes in interest rates and thus a downward pressure on principal values on fixed-income investments – but we have been here before.

Numerous industry analysts forecast a hike in interest rates at the beginning of last year. Of course Brexit and the ensuing uncertainty over the UK’s economic performance scuppered the potential hike in base rates.

On the other side of the Atlantic, sluggish economic growth and productivity were among the more pertinent reasons behind the delay in interest rate rises last year.

But times have changed. Newly elected President Donald Trump’s rhetoric of looser fiscal policies via tax cuts and bumper spending on infrastructure is predicted to lead to the tightening of monetary policy.

Markets have in turn factored in the potential of numerous interest rate rises, according to economists. It also means bond yields are likely to go up.

However, exclusive research carried out by Financial Adviser suggests that the turbulent outlook for bonds has not dissuaded intermediaries from recommending the traditional hedger of equity risk to their clients.

More than 51 per cent of the 176 advisers with investment provisions surveyed said they are very likely to recommend a bond fund over the next 12 months. Nearly 36 per cent answered “potentially” compared to just over 13 per cent who said they were not at all likely to do so.

Dennis Hall, chartered financial adviser at Yellowtail Financial Planning, said he favours short-duration bonds at present because they are less likely to be affected by increases to interest rates than longer term ones. This is because investors recover their initial investment more quickly.

“Some of these longer term bonds and high-yield bonds carry greater risk than some equity investments, but people generally seek to invest in bonds to reduce the risk level in their overall portfolio,” he said.

For a less sophisticated client, the majority of the sample (nearly 59 per cent) said they would prefer to invest in fixed income as part of a multi-asset portfolio, while only 28 per cent said the opposite.

Mr Hall said access to fixed-income assets through a multi-asset portfolio could also work for more sophisticated clients, adding: “Sophisticated is not synonymous with complicated. The suitability of this is wholly dependent on the client’s investment aims. If the individual wishes to simplify their portfolio, accessing bonds through multi-asset funds could be a good solution.”

An unnamed respondent said: “Some types of bond funds still have their place, but given markets’ apparent likely direction and the fact that most clients invested heavily in them are 'low risk’ it seems imprudent to have significant exposures to areas such as gilts, treasuries and investment-grade corporate bonds, other than in very short duration cases.”

Strategic bond funds are often touted as a good investment solution for clients amid periods of mounting uncertainty in bond markets.

This is because these products use wider investment mandates – including below-investment grade high-yield corporate bonds, and even derivatives – to achieve investment objectives, regardless of broader market conditions.