It is not just in politics that the question is being raised as to whether the future will be strong and stable or weak and wobbly – the same applies to bond markets.
Over the past 30 years, and in particular the past decade, bond investors have enjoyed exceptional performance. Since the onset of the global financial crisis, a climate of low interest rates has provided an excellent backdrop for the asset class. As illustrated in the chart, bond funds have produced extraordinary returns over the past 10 years through a combination of income and capital growth.
Of course, past performance is no guide to future returns and, in my view, this is certainly the case with bond funds. We have witnessed a huge wall of money flowing into bonds from income-starved investors over the past few years. As a result, the prices of the bonds has increased and corporate bonds valuations – government bonds in particular – are looking stretched after several years of strong returns.
I am not convinced that a bond bubble is going to burst imminently and whether we are to see material interest rate rises in the near future or not is a subject for debate. However, with little value within bond markets, the facts that interest rates have only one way to go – upwards – and inflation is beginning to emerge mean it is a tricky period to be managing fixed interest exposure.
I am not saying investors should sell all their bond exposure. There are still opportunities and certain areas of the asset class can offer the prospect for reasonable levels of income and low volatility of capital values. In addition, bonds still add diversification benefits within a balanced portfolio that invests across asset classes.
However, it is important for advisers to recognise the threats now facing bond markets and take action for their clients. Failing to do so could leave clients exposed to losses and advisers exposed to complaints.
Since the global financial crisis you could have invested anywhere in bond markets – government bonds through to high yields – and would have enjoyed equity-type returns. Ever since the aftermath of the global financial crisis, central bank policy and monetary stimulus have provided conducive support for bond markets, pushing prices up and squeezing yields.
In tandem, we have been in a sustained period of low growth and low inflation, so investors have been comfortable in paying up for bonds and lower yields as they have still been able to generate real returns. However, rising oil and commodity costs during the past year and, in the UK particularly, a weaker currency have meant inflation pressures have returned.
