Rathbones' Coombs buys gilts as insurance policy

Rathbones' Coombs buys gilts as insurance policy

David Coombs, head of multi-asset investments at Rathbones, has been buying UK government bonds (gilts) as protection from the higher levels of market volatility he thinks is coming to markets.

Many investors take the view that gilts will be a poor source of protection in client portfolios in the current market conditions because the fixed income available from such assets is likely to be worth less as inflation rises.

In addition, the Bank of England is reported to be expecting to raise interest rates three times in the next three years.

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A higher base rate is generally viewed as bad for bonds because it pushes up the interest rate available on cash deposits, making the yield available on many bonds less competitive.

But Mr Coombs said he is investing in gilts when the yield on those assets rises above 1.5 per cent.

He said he expects bond yields to keep going up.

If that is the case, he acknowledged, then the price of the bonds he has bought already will fall and he will lose money.

This is because new bonds that come to market will have higher interest rates to reflect what is coming to market, making the yield on the bonds Mr Coombs already owns relatively less attractive, and forcing the price down.

Mr Coombs said he would lose money on those investments, but that if bond yields are rising it should be a sign of a healthy global economy and/or higher inflation, which he said he thinks would be good for equity markets.

He said: "We feel the losses this will incur should be relatively small and that will be more than offset by rising values in our equity investments. On the flip side, if there is turmoil in UK equity markets, gilts should rally, making us money.

"Market risks come in very different forms and there is no one all-encompassing type of protection.

"For example, gold can be a great diversifier against deflation, but not against rising interest rates in the US.

"Therefore it is imperative that we have a range of assets providing protection against the highest probable future risks.

"We recently bought a put option on the S&P 500 index, which will make money if the market falls below a certain level. If the US market continues to rise – as we expect – then this investment will lose value.

"But the cost of this option is small and it is a sunk cost. We have paid our premium, which is just a fraction of a percentage of the fund, to protect ourselves against disaster.

"If the market falls it would hurt many of our other investments, so we are not cheerleaders for a market correction. In fact, we are optimistic about the economic situation for most of the world and the outlook for corporate profits.

"We feel there is plenty of steam left in this business cycle's boiler. But we aren't psychic; we have no idea what will happen tomorrow.