With continued mutterings regarding possible interest rate rises coming out of the US, German bunds moving into negative yield territory and the risk off approach adopted by many investors as a consequence of China slowing and the questionable future of the UK, there can be few better times to take stock of global bonds.
By and large these have treated investors well against a backdrop of anaemic global economic performance and a variety of potential upsets, both political and geopolitical. It is how they might perform in the future that we should all be thinking about, though.
The prolonged period of low interest rates and the continuing uncertainty over both economic and political progress has led to an unprecedented demand for sovereign bonds in the developed world. With inflation muted – and even negative in some areas – the risk of committing to fixed interest appears slight. All this could change, of course, if economic activity and inflation picks up, though in fairness there is little sign of this happening in the near future.
However, the massive financial experiment that has been quantitative easing cannot continue indefinitely and already the US Federal Reserve Bank is clearing the way for a return to more normal monetary policy. Much depends, of course, on the economy there – and elsewhere for that matter – not being blown off course, but the die seems to have been cast for at least a start to establishing higher interest rates.
So far Fed governor Janet Yellen has been displaying dovish tendencies, so one body of thought is that an interest rate hike might take place, to be followed by a lengthy period of stable rates that, while off the bottom, are nevertheless lower than the long-term average. Such an approach is arguably already discounted in a market that continues to benefit from the cautious tone adopted by investors since Chinese markets lost their momentum earlier last year.
Certainly, global bonds have displayed strong defensive qualities over the unsettled period ushered in during the spring of 2015. Just eight of the 59 funds with a one-year track record returned negative returns and only two remained in negative territory over the past six months. There have been some wild swings, though. Tail end Charlie over five years actually came in at number two over six months. The Goldman Sachs Global Fixed Income Sicav is hedged, but its long-term performance is dire compared with the past year, when it was tenth and returned 8.9 per cent, and six months.
Pimco, which you might reasonably expect to feature highly, actually has few funds with a sufficiently long track record to make a considered judgment. Its Global Bond ex-US fund, which leads over three and five years, slips to 26th over six months, though still beats the average with a return of 6.4 per cent. Other notable fixed interest managers, such as M&G, have a rather mixed record, demonstrating that bond markets can be every bit as capricious as their equity counterparts.
Clearly, a return to what we might consider to be more normal monetary and interest rate policies could well impinge on this sector, though it is worth noting that duration and hedging policies could well make a significant difference to outcomes. The problem for investors is that the way ahead remains unclear, with political change capable of unsettling sentiment and delivering unexpected policy changes.
Bond markets are, overall, vastly greater in size than equity markets, but have tended to remain the province of professional investors until little more than a generation ago. The level of management expertise has expanded greatly over this period, particularly in the retail investment arena. For investors seeking more predictable returns, this has proved a great bonus, but at a time when fears are being raised over debt levels and the prospect of default becomes more of an issue, care clearly needs to be exercised in approaching this sector.
Still, with inflation remaining little of a threat and continuing concerns being expressed over whether the global economy is capable of returning to robust growth, the case for committing at least a part of portfolios to this arguably less volatile asset class remains strong. Perhaps the more nimble amongst the investment community may take the view that a change in circumstances can be anticipated, though in my experience this is harder to achieve than many believe. In the meantime perhaps we should sit back and enjoy the ride in an asset class that is by no means cheap.
Key takeaway: Bond investors have enjoyed a positive run over a number of years, though the experience of investors is likely to have been mixed. Given the uncertain outlook in a number of areas, maintaining exposure to this sector for many clients seems no more than prudent. While changes in economic outlook and monetary policies will affect outcomes, for the near term little dramatic to upset this sector’s equilibrium seems likely.