Higher rates leave bonds looking pricey
UK bonds look unattractive. Even bond fund managers admit that – they “will be a poor investment in the medium term”, says Dennis Gould, head of fixed income at Axa, quoted in The Observer, who isn’t putting any in his personal portfolio. The problem is that buying by pension funds – who need guaranteed income to match their long-term liabilities – has pummelled yields.
Index-linked (inflation-protected) bonds have been particularly poor, says Philip Coggan in the FT, with real yields on the 50-year gilt as low as 0.4% earlier this year. And as interest rates rise, bonds will become even less attractive.
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But Adam Corderey of Schroders, also in The Observer, believes there is value in junk bonds (high-yield, high-risk corporate bonds). To MoneyWeek, that sounds implausible. The spreads between yields on junk bonds and safe government bonds are extremely low by historic standards, reflecting buyers’ views that there is a low risk of firms defaulting on their debts. That sanguine attitude is not only prevalent in bonds – the issuance of risky second-lien and leveraged loans has tripled in in recent years, as Edward Chancellor notes on Breakingviews.com. But these low default rates will not continue for ever. As interest rates tick up, they will also hurt consumer demand. Lower demand will cut business profits, drive up default rates and send the price of junk bonds tumbling.
by Graham Buck
