Two veteran fixed income investors have warned the market is being too optimistic about the outlook for economies and are taking a cautious approach.
Bryn Jones of Rathbones and Nick Hayes of Axa took distinctly different approaches to investing in bonds during 2020, but shared a scepticism that the current risk-on trajectory of markets was prudent.
Many lower-risk bonds and bonds with a longer date to maturity have sold off in 2021 as investors fear higher inflation.
Jones, who as head of fixed income at Rathbones oversees a fund range with £3bn of assets, acknowledged the present economic conditions of recovering economies, historically low interest rates and increased government spending, should be ideal for investing in high yield bonds, the riskiest part of the bond market, but he said he wouldn't be increasing his exposure there.
He said: “Looking at the macroeconomics, you would say this is a great time to be in high yield, but you have also to look at the fundamentals, and at present valuations, high yield bonds are priced for perfection, the time to buy them is when they are pricing in more than an average number of companies defaulting on their debts. Right now, they are priced for a below average number of defaults.”
Hayes, head of sterling rates and credit at Axa Investment Management agreed, saying that with the yield on lower risk bonds rising, "we could see people selling off their high yield bonds and buying the sovereign bonds, despite the macroeconomic outlook".
In general, lower-risk bonds have performed strongly for the past 40 years as the world adjusted to sharply lower inflation.
The price at which UK government bonds trade has fallen by about 6.5 per cent in 2021, while Eurozone and US government debt has also fallen in value.
The extent of the sell-off in UK debt can be seen in the rise in the yield available on UK 10 year government debt, which was 0.2 per cent on January 2, 2021, and is now 0.72 per cent.
Yields move inversely to prices. Yields rise for one of two reasons: either because the market has lost confidence in the ability of the borrower to make payments, or because the interest rate offered is relatively less attractive than that offered on assets which are riskier.
The UK’s vaccine roll-out programme has led to the market revising its view on the economy’s growth and inflation prospects.
Andy Haldane, chief economist at the Bank of England recently warned that inflation could rise sharply in the UK. This would make the fixed income from the bond is worth less as prices would be rising at a faster rate.
Having invested heavily in the types of bonds that did well as market sentiment became more optimistic, Jones is now looking at buying some of the assets, such as government bonds, which sold off sharply.
He says: “We have taken the opportunity of the recent sell-off to buy some of the assets that sold off, we cannot be sure that the recovery which is being seen in the US and in the UK will spread to Europe and to other parts.”