Bond fund managers have embraced the cautious approach to investing amid the current political and market turmoil.
James Foster, who jointly runs the £1.3bn Artemis Strategic Bond fund, told FTAdviser he has been buying UK government bonds as turmoil engulfed fixed income markets.
The IA Sterling Strategic Bond sector has lost 1.5 per cent in four weeks, as investors fear higher US interest rates and rising global inflation will cause bond prices to fall.
Higher inflation is bad for bond prices because the spending power of the fixed income from a bond is eroded. It also typically leads to higher interest rates, which are bad for bonds because if investors can receive a higher interest rate for holding cash they have less incentive to own bonds, causing bond prices to fall.
Typically, if interest rates are rising it is a sign that economic growth is improving, and investors address this issue by buying riskier bonds that pay higher interest rates, taking the view companies issuing those bonds will be able to make the payments in a better performing economy.
But while interest rates are rising in the US, the outlook for global economic growth has weakened. Mr Foster said the prudent course of action when interest rates are rising is to sell bonds that are less liquid and to buy safe haven assets.
He noted that gilts performed well in October, as investors viewed them as a safe haven asset. Mr Foster now has about 10 per cent of his fund invested in UK government bonds.
Gilts behave as a safe haven because the market takes the view governments will always be able to repay the money, in any financial circumstances. The market may also take the view that UK interest rates are unlikely to rise due to the current political climate, and as a result, the price of gilts is less likely to fall than the price of bonds in other markets.
The yield on a 10 year UK government bond is presently 1.39 per cent, and has risen by 0.11 per cent since the start of 2018. The yield is therefore lower than the rate of inflation, currently 2.4 per cent.
Richard Woolnough, who runs the £23bn M&G Optimal Income fund, is optimistic about the outlook for the global economy, but he is also investing in less risky bonds. He said this was because, while economic conditions point to riskier bonds being a good investment, "at present bond investors are not being paid enough to justify taking those risks, so I am not prepared to do it".
Chris Iggo, chief investment officer for fixed income at Axa IM, said US government bonds, known as treasuries, could perform better in 2019 as the cycle of US interest rate rises approaches its end.
Investors have been selling US bonds because they feel interest rates will rise, and so the income from US government debt will have less purchasing power. But as rates rise, Mr Iggo believes investors will start to anticipate that the purchasing power of the income from the bonds will start to stabilise, and that will boost the price of those bonds.