Fixed income is firmly back in favour with investors and wealth managers, however there are disagreements over the best part of the market in which to find returns.
Retail investors have invested £4bn into fixed income funds since the start of the year, according to data from the Investment Association, compared with £4.7bn withdrawn on a net basis in 2022.
Last month, AJ Bell’s chief executive, Michael Summersgill told the FT said he had never before seen the volume of fixed income purchases happening currently.
Bonds are also getting more attention from money managers, said Richard Carter, head of fixed interest at Quilter Cheviot.
If we do go into a proper recession, investors are not going to want to be in high yieldRichard Carter, Quilter Cheviot“We are seeing massive increases in demand for fixed income now, as yields are back to levels we have not seen in 10 years," he said.
His team is still investing in equities, he said, but bonds are “certainly” getting more attention from managers and clients.
Bountiful bonds
Bonds fell out of favour in the past decade as ultra-loose monetary police by central banks had resulted in comparably low returns.
But since it became clear that inflation would remain higher for more than a few months, interest rates have been hiked with unusual speed.
This was further exacerbated by the “mini” Budget in September, where the markets were spooked by the proposed unfunded tax cuts by Liz Truss’s government, driving gilt yields up to record levels.
Since the start of last year, the price of government and corporate bonds has crashed as interest rates began to rise, meaning investors could gain a similar return from less risky assets.
However for new investors, these high yields and low prices have made this market more attractive for investors than in a long time.
Differing opinions
For Andrew Balls, chief investment officer of global fixed income at Pimco, fixed income is a better bet as bond markets are pricing in expected volatility in ways that equity markets are not.
“Our expectation that central banks will maintain their credibility when it comes to price stability supports our view of bonds as a hedge against equity risk in a diversified portfolio,” he said.
The returns offered in the fixed income market are different to last autumn at the time of the “mini” Budget, said Carter, as that was “loss of confidence” in the UK government.
“This time [low prices are because] the market is thinking the Bank of England is going to have to put rates up higher, plus inflation is [more] sticky,” he said.
Moreover, he said, the negative outlook for the UK is “potentially overdone”.
“I think the numbers will gradually improve…which should support the market.”
Within fixed income, Carter likes government bonds, as there is the risk that corporate earnings will start to weaken which won’t impact gilts or treasuries.
Both Carter and Michalis Ditsas, investment director of Fixed Income, Federated Hermes Limited are looking at investment grade bonds, which Ditsas said have “historically proven resilient and reliable”.
Carter added: “If we do go into a proper recession, investors are not going to want to be in high yield.”
Cyrique Bourbon, head of portfolio strategy at Quintet Private Bank, disagreed, saying he expects European and UK investment-grade bonds to come under pressure as the European Central Bank and BoE continue to raise interest rates, at least in the near term.
“US Treasuries and investment-grade bonds, on the other hand, appear comparatively attractive as the Fed is likely to stop hiking,” he said.
But there is the currency issue, said Guillermo Felices, global investment strategist at PGIM Fixed Income.
“From the point of view of UK investors, investing in foreign assets like treasuries or German bunds involve foreign currency risks. These can be avoided via ’FX hedged’ and other instruments, but that comes with a cost," he said.
"The issue for UK investors is the currency risk of owning foreign assets, which can be avoided via FX hedges or other instruments, but these come at a cost."
For the UK in particular, he added, the Bank of England’s unwinding of its balance sheet combined with the government’s plans to issue a “significant amount” of gilts will impact returns.
“This will likely keep upside pressure on gilt yields as more gilts are issued,” he said.
sally.hickey@ft.com
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