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Bond

Summary

As we confront the ‘Spectre’ of rising interest rates in the US and here in the UK, it is worth noting the oscillations in bond markets relative to other asset classes as the media and market pundits ponder the questions ‘will they, won’t they – this year, next year? In recent days we’ve heard that a rate rise in the UK has been pushed back well into 2016 while a rate rise in the US is probable next month, depending on economic data.

As we confront the ‘Spectre’ of rising interest rates in the US and here in the UK, it is worth noting the oscillations in bond markets relative to other asset classes as the media and market pundits ponder the questions ‘will they, won’t they – this year, next year? In recent days we’ve heard that a rate rise in the UK has been pushed back well into 2016 while a rate rise in the US is probable next month, depending on economic data.
As we said in our ‘FED Up’ blog from 24 August, whether base rates and Fed funds rates are 0.25%, 0.50% or 1.00% is somewhat secondary to the availability of credit to allow economies to function properly.  You may recall at the outset of this decade, short rates were as low as they are today but there wasn’t much lending taking place and economic activity suffered as a consequence.
Nevertheless, markets are extremely sensitive to the prospect of rates going higher.  If you believe conventional rhetoric, then bonds, especially government bonds, should be the place to hide to gain relative stability at times of market stress.  However that may seem counter-intuitive as official rates are about to go up.  A key reason bond markets are more twitchy than history would suggest they should be is that quantitative easing has driven bond yields to historically low levels, none more so than in Europe where 10 year German Government bonds yield just 0.60%.  The equivalent 10 year gilt yields 1.94% at the time of writing and up 0.14% in yield over the past month.  These extremely low yield levels have pushed bond yield seeking investors to take on greater credit risk by buying investment grade or even high yield corporate bonds.  The fear across bond markets is that the days of yield suppression are over.  In markets where there is less risk capital at work from dealers, reduced liquidity amplifies the price and yield gyrations on what are often looked upon as defensive assets.
So what can an investor choose as an alternative?  The popularity of mixed or multi-asset products has been well documented and demand for them continues.  They come in many guises.  Looking at the Investment Association (IA) sectors on the following chart, Flexible Investment, Mixed Investments and Targeted Absolute Return are the obvious candidates but the latter has delivered the standout risk (as measured by volatility)/return trade-off over the past three years.  That makes sense as the purveyors of funds in that sector are driven by the desire to meet a stated return profile and are less subject to the vagaries of a single asset class or an IA peer group.  For those who consider Flexible or Mixed Asset Investment funds, it may be worth looking at our own Dynamic Fund, a multi-asset investment solution where the risk/return trade-off has its merits.
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So while the bond markets wait to ‘Die Another Day’, recent performance data suggests looking beyond the bond sectors for more appealing bond-like characteristics. While bond markets aren’t akin to a trip to the ‘Casino Royale’, there would appear to be less volatile alternatives available.

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