Talking Point 

Bond markets under Brexit cloud

Bond markets under Brexit cloud

Brexit is a “massive cloud” hanging over the UK and European bond markets, James Rieger, head of global fixed income at S&P Dow Jones Indices, has warned investors.

He said bond markets do not like uncertainty, so the prospect of the UK’s departure from the European Union could spur a flight to quality assets.

The inflationary environments in the US and UK after a long period of low rates were not necessarily negative for bond markets as inflation will help drive the underlying GDP of those economies.

What bond markets would not want to see is inflation exceed central banks’ targets, he said.

The Bank of England and US Federal Reserve have an inflation target of 2 per cent respectively.

Mr Rieger also told investors to expect yield volatility and remarked he had “never seen this kind of environment in bond markets globally” before.

“The stretch for yield has put some investors at risk,” he said, with investors forced to buy less liquid assets in a bid to meet their “insatiable” need for yield.

He suggested investors might be better in floating rate securities, such as senior loans, which move up and down with rates in a rising interest rate environment, although he cautioned there is still “an element of risk” in these assets.

Mr Rieger observed the growing trend for allocating to passive fixed income products, which allowed investors to buy a fund at a lower cost and trade during the day, was “a more efficient way to gain exposure than even mutual funds”.

But he acknowledged investing in a mutual fund would offer more diversified exposure and be a more efficient way of allocating to bond markets than purchasing individual bonds.

Martin Bamford, chartered financial planner at Informed Choice, said fears of a bond bubble have been overstated though.

“Investors should continue to allocate across a range of fixed income vehicles, tactically shifting their allocations away from gilts and investment grade corporate bond assets towards higher yielding debt and also overseas bonds,” he explained. 

“Fixed income managers have been cutting duration in recent years and this will also help to reduce the sensitivity of these funds to interest rate rises.”

He added while he expected interest rates to rise gradually and modestly, fixed income as an asset class “should be able to tolerate this without a significant loss of capital”. 

Mr Bamford noted: “Investors should, however, temper their return expectations for the asset class, as double digit returns look less likely in the future. The main motivation for holding fixed income within a portfolio should be for its diversification benefits and to provide a steady stream of income.”