Can bonds still shelter you from inflation storm?
Once trusted to thrive when shares tumbled . . .
THE word ‘bond’ usually produces a feeling of calm, but presently it is having the reverse effect. Such is the anxiety about the outlook for the $ 100 trillion (£82trillion) global bond market that in the first week of this month, investors worldwide withdrew $9.7bn (£7.9bn) from bond funds.
Is this flight the right response, as concern mounts that we could face a period of stagflation when growth is sluggish and the cost of living spirals?
Or is the pessimism overdone, making this the moment to reassess the merits of bond funds, particularly if you need an income?
The rush for the exit was spurred by alarm over soaring inflation and interest rates, which were raised again in the UK and the US this week.
For bonds, rising interest rates and inflation are a toxic combination.
They reduce the value of the fixed income paid out by bonds and of the capital invested.
Bonds come in two categories – sovereign debt issued by governments to raise funds, and corporate debt issued by companies for the same purpose.
The sense of foreboding is evident in the figures covering corporate bonds, UK government gilt-edged stocks or gilts (so-called because the certificates used are gilt-edged) and US Treasury Bonds or ‘Treasuries’.
The Bloomberg Global Bond Aggregate index is down 15pc since the start of the year and the average UK government giltedged bond fund has fallen by about 14pc.
The yield on a ten-year gilt is 2.54pc, against about 1pc in January, while the yield on their US equivalent, a 10-year US Treasury, is 3.29pc, up from 1.76pc over the same period.
YIELDS, which move inversely to bond prices, have been driven up by the quantitative-easing (Qe) schemes in which the Bank
of england and other central banks bought up bonds to pump money into economies. hardest-hit in the turmoil have been longer-duration bonds, set to mature from ten to 30 years hence.
These are regarded as riskier since investors must wait longer for the return of their cash.
Index-linked bonds, which offer inflation-proofing, have not been spared in the rout. As some investors will remember with nostalgia, bonds used to be the comfort blanket element of a portfolio, trusted upon to thrive when shares tumbled.
But, while optimism is in short supply, could such conditions offer an opportunity?
US giant Citi has been suggesting for some weeks that this is the moment to get into bonds. It’s a view gaining popularity. But if you would like some exposure to the sector, tread cautiously.
Contrary to what you would suppose, index-linked gilts do not necessarily provide protection against inflation unless held to maturity. When inflation is surging, they can lose money.
high-yield bonds sound alluring, but they are issued by companies with lower credit ratings, which means a larger risk of default.
Jason hollands of Bestinvest comments: ‘Corporate bonds offer a higher degree of security for investors in the event that a business goes bust, since bondholders are higher up the pecking order for receiving any share of remaining assets than shareholders.
‘Over the past decade, the level of defaults has been low. But, with the chances of a recession growing, defaults are destined to rise.’
James Yardley, senior research analyst at Chelsea Financial Services, also counsels caution: ‘Bonds are starting to look a little bit more interesting again. But I’d be particularly wary of corporate or high-yield bond funds just now.
‘There’ll probably be a good chance to buy corporate bonds in the coming months, but I would wait for a recession to be fully priced in before doing so.’
Chelsea Financial Services has been increasing clients’ exposure to Treasuries as ‘an excellent portfolio diversifier’, while warning that if inflation remains elevated, there could be more pain to come.
Yardley adds: ‘The yields on gilts and european sovereign bonds are still pathetically low. The risk/ reward for these is still not in the right proportions. The funds we like are M&G Global Macro Bond, Black Rock Corporate Bond and GAM Star Credit Opportunities.’
These funds hold a mix of gilts and the bonds of household name businesses.
hollands acknowledges that the income on offer from bonds is improving, but he points out that the yields are still below the rate of inflation.
his bond choice is the MI Twenty Four dynamic Bond, where managers deploy what they call a ‘highly flexible’ strategy.
This is the approach that anyone venturing into bonds now should adapt. They were the laidback option, but that is just not so any more.
PRIMARK should in many ways be well placed to weather the cost of living crisis, and shareholders will look for any impact that the squeeze on households will have when its parent, Associated British Foods (ABF), reports third-quarter results next week.
The business is hiking prices later this year, but it is unlikely to lose its crown as one of the cheapest clothes retailers.
Many brands may see customers leave for cheaper alternatives and end up in Primark, whose own customers may struggle to find lower prices elsewhere, so will continue shopping at the retailer, or cut back on clothes.
‘Inflation will be the word of the day when ABF reports,’ said Laura Hoy, analyst at Hargreaves Lansdown.
‘The buoyant half-year sales were back to pre-pandemic levels as stores reopened. The surge in demand fed through to a 92pc increase in operating profits but good times might not continue if rising costs continue to eat into margins.’
Inflation is at a 40-year high, hitting 9pc in April this year. New figures for May from the Office for National Statistics are out next week.
The high cost of energy is also feeding into business supply chains around the world.
Primark is no different. Bosses have already said that prices will need to rise this autumn to make up for soaring costs.
Hoy added: ‘Demand this year in the face of the current cost of living crisis will give us an idea of how resilient customers are.’ ABF also owns brands, such as Twinings tea.