While gilts have provided a safe haven for investors in tough times, funds in the sector will not offer that same protection as global monetary policies shift. Paul Burgin reports.
Those retail investors who have held UK gilt funds since the worst of the financial crisis in 2008 should be feeling fairly smug. Capital appreciation has been strong as yields have fallen. Global bonds and sterling corporate bonds may have performed better on average over the last five years, but the UK Gilts sector still produced total returns of 32.9% with a far less volatile trajectory... until recently.
Long-dated gilt strategies had produced the best longer-term returns on the expectation that interest rates will remain low.
The threat of an earlier than expected tapering of quantitative easing (QE) in the US, however, has shaken investors out of their low-rate torpor in recent weeks. Long-dated gilt portfolios have dropped furthest over the shorter term, allowing their short-dated peers to climb the rankings.
Why investors with long standing gilt holdings are feeling smug
Philip Laing, investment director for government bonds at Standard Life Investments, says investors can thank the Bank of England (BoE) for the relatively painless ride in recent years.
“The monetary policy committee, under Sir Mervyn King, has done a remarkable job of ‘managing’ the bond market. Despite only paying lip-service to its inflation remit, the committee has succeeded in driving bond yields down and keeping them low,” he says.
Yet he still thinks gilts will struggle in 2014. Indeed, there is plenty to keep investors guessing about where next for monetary policy and the impact on gilt values and yields.
“The effectiveness of QE has been questioned and inflation targeting has been made more flexible. Meanwhile, King surprisingly voted to add a further £25bn to QE, talking sterling lower returned as a policy focus for the MPC and all meetings have seen multiple split votes,” adds Laing.
Less to cheer
Mitul Patel, co-manager of the Henderson Institutional Gilt and Long Dated Gilt funds, admits that government bond investors generally cheer when economic news is bad. Now the economy appears on the mend, they have less to be happy about.
“The economy is showing signs of improvement and the market is trying to price back in a rise in interest rates, which is why yields have risen. It is all dependent on the data. The UK probably has the strongest economy of the developed markets right now. PMIs are the strongest they have been for some time and housing and manufacturing are up. There are also anecdotes and signs that hiring is picking up,” he says.
What is good for the economy is bad for gilt holders’ capital values when interest rates rise. Mark Carney’s first inflation report introduced forward guidance on rate policy for the first time. Even so, when rises will take place is far from certain.
This article continues…
To promote 'long-term investment'
Switching 'hard and expensive'
Smaller funds still packing a punch
To drive progress