A report in the FT caught my eye last week. It said pension funds were putting even more money into sovereign debt. As far as I could tell this was through the long term matching of liabilities. All very clever stuff from those super clever actuaries at the heart of it. Yet wasn’t it the clever people who contributed to the financial mess we are in today? Those carefully-designed derivative products that all blew up for example.
Today, 10-year gilts on yields of 1.5 per cent – 2.0 per cent, well below that of inflation, still seem to be perceived as safe and low risk. If you want to scare yourself just look at a chart of gilt yield from 1990. It’s like looking down a black run. The same investment performance cannot be repeated and while yields could fall further still, or at least stay where they are for a while longer, it is clear there is asymmetric risk.
We still hear bonds are being bought for their characteristics of high income and low volatility. Anything with perceived low risk and high yield is in demand. Direct to retail bonds are selling like hotcakes. This may well continue for some time, but I wonder whether the clever people have any real answer to reversal when it comes – which it surely will.
For those too young to remember I suggest you look back at February 1994 when the Federal Reserve suddenly raised interest rates. Gilts had their worst year in over 30 years. This time when the reverse comes it will make 1994 look like a picnic. So look carefully at those textbooks which tell you all about the risk free rate of return. They were written before the markets were distorted by central bankers and politicians – not that I think they were ever really a true reflection of the real world.
Mark Dampier is head of research at Hargreaves Lansdown