What next for the Bond market?

For a number of years now, Gould Financial Planning have held the view that the bond market is overpriced. We have felt that with the long bull market that we have seen, and with interest rates likely to rise at some point, clients should be looking to minimise their exposure lest they suffer what we saw as an inevitable fall in prices.

As well as advocating that our clients hold a low weighting in the low risk asset class, as far as their risk profile allows, we have also preferred for them to utilise strategic bonds as much as possible. These funds give managers the ability to invest across the fixed interest spectrum and react to market conditions as they see fit. Just as importantly, they allow managers to adopt short positions and potentially benefit from a falling market.

Admittedly, and with the benefit of hindsight, it now looks like this call was made too early and the bond market has continued to trend upwards. 2014 in particular was a good year and we saw our in-house low risk benchmark rise by 13.4% (a stark comparison to our UK equity index, which grew by just 0.3% in 2014)*.

There are various reasons why the bond market prospered throughout 2014 but the most obvious seems to be that interest rates remained at their historically low levels. We should note that we were not alone in making this call – many strategic bond managers took more defensive positions in 2014 in preparation of a price decrease.

There are now however signs that the market is correcting. Global government bond markets have seen record four-week declines (click) and the International Monetary Fund (IMF) recently expressed concern about a potential collapse in the market (click). Both of these events send signals that we could finally be seeing the end to the bond markets positive run and reinforces our long-held in-house position.

This article (click) featured in the Financial Times last week assesses whether this is merely a blip or if we have actually reached the tipping point.

Whether this correction is short or long-term, our view remains the same. In our opinion, with inflation and interest rates so low, any area of the market generating a return of 13.4% in a year cannot justifiably be referred to as low risk. Therefore we are still advocating a heavier than usual cash holding, and for the risk to be taken in equity markets where at least the risks of investing are accepted and understood.

*Please note past performance is not a guide to future performance and the value of investments can fall as well as rise. You may not get back what you invest. The table below details the last 5 years discrete performance for our low risk benchmark:

Year 2014 2013 2012 2011 2010
Benchmark 13.4% -2.2% 7.2% 11.8% 6.8%

These figures are based on our benchmark; a composite index of the iShares Core £ Corporate Bond UCITS ETF (50%) and the iShares Core UK Gilt UCITS ETF from 1st January to 31st December for each discrete year.

If you want to discuss this article in greater detail please contact Owen Harris on owen.harris@gouldfp.com or 01633 653186.