Inestors are now paying to hold a third of the debt issued by developed market governments, and yet yields continue to fall – even where they are already negative. Bonds, for generations a staple holding in a mixed portfolio, in many cases now guarantee owners a modest loss. They also pose the risk of a potentially large capital loss, leading to some of the biggest fans of these assets warning savers to sell up and switch into cash.
Negative yields on bonds (see Page 3 for a full explanation) arise because low interest rates have forced investors to chase yield, driving up the prices of income-generating assets and in turn crushing their yields.
The extremity of the markets – the decision in America to hold interest rates depressed yields further on Thursday – has led to some of Britain’s biggest bond owners turning sour on the sector. Richard Woolnough, who runs the £15.5bn M&G Optimal Income fund, told investors that falling bond yields meant fixed-income assets had lost their advantage over cash (his comments are on Page 3).
Mr Woolnough said that until recently bonds held their edge over cash because the income on offer compensated investors for the potential capital losses. However, with bonds now offering minimal or no income, that risk of capital loss has become too great.
It’s not the first time a feted bond fund manager has warned on market conditions. Three years ago bond fund manager Chris Bowie, who then ran money for fund group Ignis and is now at TwentyFour Asset Management, warned investors to sell. At the time, his warning was based on bonds’ failure to yield more than inflation. Today, although inflation has fallen, the situation is worse – with many of the same bonds yielding nothing or less than nothing.
Cash is the answer for many professional portfolio managers, with cash positions reaching levels unseen since the period after Lehman crash in 2008, according to the latest of regular surveys by Bank of America Merrill Lynch. When quizzed on why cash levels were high, fund managers said they had a bearish view on markets and prefer cash over lowyielding equivalents.
What’s more, 82 per cent of the managers believe bonds issued by developed markets are too high. But the problem is spreading out into other assets, as investors crowd into high-quality stocks, US and European corporate bonds and emerging market bonds.
So what does this mean for individual investors?
Mike Deverell, investment manager at Equilibrium Asset Management, said the current market means the traditional investment model of 60pc stocks and 40pc fixed income – quality bonds – is “dead”. He has reduced equity and fixed income exposure in his portfolios and built up cash. Tom Stevenson, investment director at
Fidelity, the fund manager and broker, said that around $13 trillion of government bonds are now offering negative interest rates, a “pretty extraordinary state of affairs”. “It is fair to say government bonds at today’s prices are very unattractive,” he said.
“Why would you lend money knowing you’re going to get a negative return? In large parts of the market you are getting close to zero or negative yields. For an everyday investor what is the point, particularly as they are going to pay a fee on top of that for a fund?”
The only reason an investor would hold these bonds is if they believe in the “greater fool theory”, said Mr Stevenson: “Buying bonds at these prices only makes sense if someone else will pay an even higher price than you, and that doesn’t seem like a very prudent basis for an investment.”
But with Bank Rate at 0.25pc and possibly set to fall further, and savings accounts offering next to nothing, cash is not appealing.
“I think as a short-term solution it makes sense but as long-term move cash absolutely doesn’t make sense,” said Stevenson.
Instead, investors have two options: accept lower returns or move up the risk spectrum.
Lee Robertson, chief executive of wealth manager Investment Quorum, said investors have to “reset” their expectations of the kind of investment world we are living in.
Corporate bonds, although riskier than those issued by governments, can offer better returns, but only in pockets of the market. The hunger for yield has now filtered through into the corporate bond market, too, and some corporate bonds from blue-chip companies are trading at negative yields – just like the government debt of developed economies.
This has been made worse in Europe by the European Central Bank’s programme of buying corporate bonds as part of its “quantitative easing” programme, a move the Bank of England is now following.
“Negative rates have stretched out into corporate bonds, and some of the stronger companies are issuing debt close to 0pc, but those aren’t widespread and corporate bonds still look attractive generally,” said Adrian Lowcock of Architas.
Unilever, the company behind household brands such as Persil, Walls and Hellmans, has issued a bond paying no income; while bonds from companies such as healthcare giant Johnson & Johnson and industrial company General Electric already have negative yields.
One way to navigate this is to use strategic bond funds, where managers have the resources and time to adequately research the parts of the market that are paying a decent income, advisers say.
“We like strategic bond funds,” said Mr Deverell, “which target higher yield corporate bonds and are safer. You can get 4pc to 5pc distribution, which is a lot better than you get from government bonds.”
However, Jenna Barnard and John Pattullo, managers of the £1.7bn Henderson Strategic Bond fund, have warned investors to expect lower yields across the market.
Mr Pattullo warned investors will continue to get income from bonds, but that ”capital gains from here is getting a lot more challenging”. Away from bond market, investors who are willing to take on more risk can still find returns.
“Bond proxy” companies, the likes of Unilever and Proctor & Gamble, “still offer a higher and sustainable dividend income,” said Mr Stevenson.
“Equity income remains pretty attractive. In many cases you have got blue chip companies offering higher income on their equity than the bonds they issue, so equities are a better hunting ground for income than bonds,” he said.
Unilever, for example, currently yielding 2.7pc, has increased its quarterly payouts this year so far. These companies are protected against any potential downturns, as they have solid repeat business, said Mr Lowcock. “But if the economy grows more aggressively than it has been doing, then ‘ bond proxies’ don’t tend to do so well.”
Equity income funds are one way for investors to access a range of these companies in one place. Mr Robertson said the Newton Global Higher Income fund and investment trusts, such as City of London, were currently offering good yields.
Despite recent scares over property funds, which saw a number of “openended” commercial property funds preventing withdrawals amid panic after the Brexit vote, opportunities remain in the property sector for decent yield.
Mr Deverell has made a “small allocation” to the Kames Property Income fund, which is currently yielding 5.75pc and is 9pc cheaper than before the referendum. The fund also has no allocation to London property – an area Mr Deverell thinks is more prone to devaluation.
“Don’t discount property,” said Mr Robertson, who is invested in the F&C Commercial Property trust. “It has When investors are fearful of shares and other risky assets, they buy government bonds, driving up their prices. In extreme times, as now, the price paid can be higher than the face value of the bond plus the interest that remains to be paid before it matures. A loss is guaranteed for those holding to maturity. The greater the fear in the market, the greater the loss investors will be prepared for. Others will hope to profit if further panic drives prices yet higher.
had a bit of a rocky time but it seems to be coming back.”
Other areas where Mike Pinggera, manager of the Sanlam FOUR multiasset fund, is unearthing income, include infrastructure, renewable energy and student accommodation.
In the infrastructure space he has moved into the HICL Infrastructure trust and 3i Infrastructure, which are yielding 2.5pc and 3.8pc respectively. “Real assets produce an income immediately but with long-term linkage to inflation,” he said.
“I think it is a challenge for everybody, there is no doubt about it. Generating returns will remain a task,” Mr Pinggera said.
“I do think that it is right to expand investment horizons. You can make incremental increases to the yield of the overall investment portfolio by taking small positions in different things and collectively push up income,” he said.
However, Pinggera, who said he is “kissing every frog that is coming through the door” in a bid to find yield, says he is not yet moving into newer areas, such as peer-topeer lending.
‘I will kiss every frog that comes through the door in my search for income’
Sake, Japanese rice wine, is growing in popularity – and not just among drinkers. One enthusiast, Andy Travers, 34, from London, already has several bottles and said the arrival of British brewers offered further opportunity for investors.