By Kenneth Baler, a fund manager at Baillie Gifford Bond fund managers have attracted an unusual...
By Kenneth Baler, a fund manager at Baillie Gifford
Bond fund managers have attracted an unusual level of interest in investment firms lately. Once looked on as a dull backwater the terminally risk-averse bonds are now in their third calendar year of outperforming equity markets.
Many investors are now increasing exposure to bonds and reducing equities. Corporate bonds, in particular, are attracting considerable attention.
And why should they not? Are they not the perfect investment for these times? Predictable revenues and far fewer worries about valuation than equities. Inflation, which devastated bond values in the 1970s, is expected to stay low for the foreseeable future.
The major grumble concerning government bonds ' that their yield has become too meagre ' is offset by the extra income earned on corporate bonds. Retail bond investors are also in great company as many institutional investors, such as pension funds and insurance companies, are increasing their allocations at the expense of equities.
We believe the environment for bonds is likely to stay healthy. Inflation will remain under control and investor demand is strong.
Economies are only slowly recovering and central banks are in no hurry to increase interest rates. The global political and economic uncertainty pervading today is likely to continue and this may make equity markets volatile and unpredictable.
Bonds are less affected by this factor. Money in the bank currently earns a low rate of interest, inducing private investors with a need for income to look elsewhere.
As a reality check, most commentators expect equities to generally outperform bonds over the medium term. Bonds cannot offer much in the way of capital gain with yields already low. For this reason, investors with a longer time-frame should not neglect equities.
Over a shorter horizon, one can point to the more reasonable dividend yield offered today as a positive sign for equities.
Yields on bonds are low by recent historical standards offering only a modest hurdle for equities to overcome.
As a higher octane choice one should consider high yield bonds. This market has suffered from high default rates due firstly to over-expansionary telecom and cable-TV companies and lately due to fallen angels ' large investment-grade companies which have fallen on hard times (WorldCom and Enron being the prime examples).
More economically sensitive than conventional corporate bonds, we believe high yield bonds share many attributes with equities.
Accordingly a good high yield fund should follow similar precepts to a good equity fund ' consistency of investment policy, adequate diversity and good risk controls.
The potential rewards are high ' Merrill Lynch's Sterling High Yield Index currently yields more than 12%.
When financial markets stabilise, high yield funds should be among the best performers.
Central banks keeping interest rates low.
Superior income to equities.
Lower risk than equities.
Relatively low yields available.
Little capital appreciation.
Higher yield bonds are more risky for investors.
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