Long-dated gilts are looking expensive as insurance companies are forced to buy them to cover liabil...
Long-dated gilts are looking expensive as insurance companies are forced to buy them to cover liabilities for guaranteed annuities they sold in the past. This is causing a drain on the supply and fund managers are considering long gilts unattractive at current prices.
George Luckraft, manager of ABN Amro High Income unit trust, says: "There is weakness in the gilt market in some areas of the curve. At the long end of the market the returns are not very strong but 10-year bonds are starting to look a bit more interesting as a result of a reversal on interest rates expectations.
James Gledhill, head of corporate bonds at M&G, agrees. He says: "Corporate bonds, in line with government gilts, have been poor performers recently. Gilts are now backing up as it appears the economy is stronger than expected. Investors are no longer expecting interest rate cuts but expect hikes and this is being priced into the five- to 10-year area of the yield curve. The long end, driven by problems with guaranteed annuities, is suffering a shortage of supply.
The Bank of England appears likely to raise rates from 5% to stem concerns of rising inflation. At the moment the bond market seems to be factoring in that interest rates of 7% by the end of next year. Gledhill says: "This makes the market fairly attractive and offers some amount of value. We will be moving some assets out of the long area of the curve and going a little shorter. The long end is priced around 4.75% which is expensive compared to 5.6% in 10 years.
The danger in short-dated gilts is that no one knows where the peak in rising rates may be, says Wade Pollard, senior fund manager for HSBC High Income
He says: "The pendulum has swung in the opposite direction and most think the next move in rates will be upwards. Gilts are closely linked to base rates, when rates are falling no one knows where the bottom is and valuations tend to overshoot because of momentum. If rates rise then yields will keep rising because investors are nervous. It will only be when we reach high enough rates of interest to slow growth that people will relax.
Although not typically involved in the high yield market, Johnson Fry says it believes there may be better value in this area of the market if interest rates do rise.
Richard Neill, chief investment officer at Johnson Fry, says: "We have avoided straight debt for some time for the very reason of the absurd yields that were being offered. If there is a rate hike though, we would look more to buying government and corporate debt but keep to the short duration bonds. I do not expect interest rates will hit 7% by the end of next year but they will go up and spreads will widen further.
While most are bearish concerning long dated gilts, because of the current shape of the yield curve, Pollard does not believe that long gilt yields will fall any further. He says: "I also still feel that there is good value in long dated corporate bonds and preference shares. With economic growth, company profitability should be good and credit risk lower. Corporate bonds have a significant premium to gilt edged securities.
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