With yields on UK government bonds at low levels the scope for further capital gains is somewhat lim...
With yields on UK government bonds at low levels the scope for further capital gains is somewhat limited. But fund managers say that regular coupon bonds still deliver, which means they will continue to attract investors wanting security in a time of equity market volatility.
Royal London Asset Management head of fixed interest Jonathan Platt says while the gilt market may be at a peak, prospects for further gains remain while the equities are under a cloud.
'The outlook for UK government bonds depends on the outlook for the equity market ' it will do the reverse of whatever the equity market does. If the equity market keeps going down, there is still scope for the gilt market to go up,' he adds.
The bulk of UK gilt funds can do little to limit capital falls when the market enters a period of decline. But relative outperformance is enough for many bond investors, who are often more attracted to the yields on offer than the prospect of capital gains.
'Most investors in government bonds are long-only, and that reflects the demand of the client base for solid, secure income flows. They are not really looking for aggressive capital positioning ' they want the stability that government bonds offer,' Platt says.
One method of driving performance is to adjust the average duration of bonds held in the portfolio to increase or lower exposure to moves in the market.
'Most government bond funds are run relative to an index, so if you are cautious on the market you will have less exposure to long-dated government bonds than the benchmark,' Platt says.
Royal London is broadly neutrally positioned, although its long-dated funds are slightly short of benchmark duration, he said. Any hostilities in the Middle East would be likely to see an immediate move south in the equity market, in turn boosting bonds.
'I don't think the market is yet pricing in the certainty of war in the Middle East, but if it does happen, I think government bonds will get a bid for the fact that they are relatively secure in comparison with equities,' Platt says. 'I don't think that would last very long, but the world economies are so precariously balanced that any hit to confidence could be enough to lead to a double-dip in the US. If we then had price deflation and it became more of a global phenomenon, UK government bond markets could continue to do well.'
Speculation that Chancellor Gordon Brown is set to reduce economic growth forecasts has raised the prospect of an increase in bond issuance to fund government spending, which would be a negative for bond prices.
'But the ongoing demand from life and pension funds means that as long as growth does not disappoint dramatically, the deficit between expenditure and revenue should be handled by the market,' Platt says.
Threadneedle Sterling Bond fund manager Daniel Loughney believes there is room for further gains in bond prices.
'Real yields are not too far out of line with historical norms, so on that basis and the perception that growth and inflation will remain low, I think they are quite reasonable value,' he says.
Demand by life firms supports the market.
Inflation, economic growth to remain weak.
Uncertainty of equities make bonds attractive.
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