Much of the jargon used on this subject can be somewhat confusing for the investor.
In this article we aim to highlight a few key concerns we currently have about the bond market and hope this provides a better understanding of the subject.
Risks are increasing for bond investors: Bonds have historically been used successfully in portfolios to provide diversification and more stable returns. However since the financial crisis in 2007 and the subsequent Quantitative Easing (QE) programmes, bond yields have been driven to historically low levels. This has seen the valuation of bonds, as measured by high prices and low yields, trade at extreme levels. The yield on US Government 10 year bonds is at its lowest point since 1950, and UK and German 10 year bonds are the lowest on record. Furthermore, over the past year global bonds have been twice as volatile compared to historical levels. If a client invested purely in bonds the volatility would actually be higher than the designated volatility range of our most aggressive monitored portfolio – this offers some perspective.
Are we at the end of a period of falling interest rates?: Bond prices are inversely correlated to interest rates (when bond prices go up, yields go down). As the potential for increased interest rates reduces the possibility for bond yields to continue to fall and conversely the potential is for yields to start rising, the risks for bonds as an asset class are increasing and it should no longer be viewed as a lower risk strategy with the potential for ongoing capital growth. Realistically, how much lower can bond yields go (recently we have seen a global bond sell off begin)?
Liquidity conditions are weakening: Since the financial crisis we have seen at least a 25% cut in number of market makers (people who facilitate buying and selling in the banking sector) as banks have significantly cut their operations, due to increased capital and balance sheet requirements. Demand for bonds has increased due to QE and investors have been willing buyers from investment banks balance sheets over the last 8 years. Liquidity is currently running at around 25% of pre-2008 levels and a removal of QE or any reduction in mutual fund demand, could see a bond market with many sellers but no buyer of last resort.
Negative interest rates: Negative interest rates have consequences for bond investors, as while there may be an argument for rates to go further into negative territory, this limited capital growth is offset with a negative yield. The risks of owning bonds with a negative interest rate is unknown as they have never been negative in history before. Higher interest rates or even a return to zero interest rates will see capital losses for investors.
Whilst there are many factors to consider when structuring an investment portfolio, the above should also be taken into account in the current period.
The above is provided for information purposes only and we recommend that professional independent advice is taken prior to making any decisions or taking any action.
In this article we aim to highlight a few key concerns we currently have about the bond market and hope this provides a better understanding of the subject.
Risks are increasing for bond investors: Bonds have historically been used successfully in portfolios to provide diversification and more stable returns. However since the financial crisis in 2007 and the subsequent Quantitative Easing (QE) programmes, bond yields have been driven to historically low levels. This has seen the valuation of bonds, as measured by high prices and low yields, trade at extreme levels. The yield on US Government 10 year bonds is at its lowest point since 1950, and UK and German 10 year bonds are the lowest on record. Furthermore, over the past year global bonds have been twice as volatile compared to historical levels. If a client invested purely in bonds the volatility would actually be higher than the designated volatility range of our most aggressive monitored portfolio – this offers some perspective.
Are we at the end of a period of falling interest rates?: Bond prices are inversely correlated to interest rates (when bond prices go up, yields go down). As the potential for increased interest rates reduces the possibility for bond yields to continue to fall and conversely the potential is for yields to start rising, the risks for bonds as an asset class are increasing and it should no longer be viewed as a lower risk strategy with the potential for ongoing capital growth. Realistically, how much lower can bond yields go (recently we have seen a global bond sell off begin)?
Liquidity conditions are weakening: Since the financial crisis we have seen at least a 25% cut in number of market makers (people who facilitate buying and selling in the banking sector) as banks have significantly cut their operations, due to increased capital and balance sheet requirements. Demand for bonds has increased due to QE and investors have been willing buyers from investment banks balance sheets over the last 8 years. Liquidity is currently running at around 25% of pre-2008 levels and a removal of QE or any reduction in mutual fund demand, could see a bond market with many sellers but no buyer of last resort.
Negative interest rates: Negative interest rates have consequences for bond investors, as while there may be an argument for rates to go further into negative territory, this limited capital growth is offset with a negative yield. The risks of owning bonds with a negative interest rate is unknown as they have never been negative in history before. Higher interest rates or even a return to zero interest rates will see capital losses for investors.
Whilst there are many factors to consider when structuring an investment portfolio, the above should also be taken into account in the current period.
The above is provided for information purposes only and we recommend that professional independent advice is taken prior to making any decisions or taking any action.
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