A worldwide sell-off in government bonds deepened this week, driven by weakness in German Bunds, where the benchmark yields have risen from 0.05% to current levels at writing of approximately 0.70%. This has caused many conversations on the desk at MitonOptimal over the past few days, so I felt we should share some thoughts with everyone.
Firstly, beware the consensus. Last week, everyone was forecasting that the German Bund 10 year yield would go negative and the spread, or gap, between US 10 year Treasuries would widen. In fact, whilst US 10Y yields have moved out towards 2.25%, this spread has actually narrowed.
Why this is happening this week remains a mystery. This comment from one of our cash / fixed income managers at TwentyFour Asset Management in London appears sensible.
“Since Feb the disinflationary chat has ground to a halt and the rhetoric is now all about the strength of the recovery. In the US it is no longer about rates rising ‘sometime in the distant future’ and when ‘normalisation will begin’ but ‘in which month’ this will happen. The recent weakness in US economic data has merely pushed back expectations from a June lift-off to a September one; both of which are just around the corner in economic terms. We can argue all we like about the data not supporting a rate rise yet, but the Fed does seem very keen on pursuing a gradual normalisation of monetary policy. It is the realisation of this point that markets have become concerned with.”
At MitonOptimal, we have argued for many moons that lending money to Governments at these ludicrously low levels, for long durations, is a guaranteed way to lose wealth in real (and nominal terms). Equities may no longer be cheap in absolute terms, but they are still attractive compared to very over-valued government bonds.
We have, therefore, advocated exposure to managers focusing on floating rate notes, short duration credit and selected Emerging Markets, together with those with the ability to go long and short is the preferred allocation within fixed income. My colleague Shaun produced the following table, as at mid-Wednesday 6th May, showing performances of indices versus those of our preferred bond funds since bond markets headed south on 24th April.
|24/4 to Date||QTD|
|iBoxx GBP Index||-2.74%||-3.32%|
|FT Gilts (all)||-2.76%||-3.35%|
|Bloomberg High Yield USD Index||0.03%||1.04%|
|M&G Optimal Income||-0.25%||-0.15%||3.0 Yr duration; 24% Gov, 59% IG Credit, 29% High Yield; average rating BBB|
|Jupiter Dynamic Bond Fund||-0.92%||-1.01%||4.84 Yrs; 24$ Gov, 7% IG Credit, 57% High Yield & 12% (!) cash; average rating BBB|
|New Capital Wealthy Nations Bond Fund||-0.52%||1.08%||8.03 yrs; 19% QAT, 18% CHN, 13% RUS, 8% Abu Dhabi & HK, 5% UK & CHL|
|TwentyFour Monument Bond Fund||-0.01%||-0.03%||0 yrs (RMBS); 77% UK, 9% NDL, 8% ITA, 3% SPN & POR; 40% AAA, 32% AA, 18% A, 7% BBB|
|Ignis Abs Rtn Gov’t Bond Fund||-0.64%||-0.17%||Long UK, SWE, JPN & NZL s/t rates; long USA, DEU, JPN, AUS & NZL m/t rates; long USD, short GBP & JPN; long EZ & JPN Inflation; long UK vol|
|Liontrust Global strategic Bond Fund||1.18%||4.60%||0.9 yrs, 48% net long; short USTs & JGBs, USD & EUR corps, long BRA & RUS hard & local ccy sovs (BRL hedged), MEX local ccy sovs; short GBP, PEN & TRY, long COP|
|Smith & Williamson Short Dated Corp Bond Fund||-0.47%||-0.48%||3.0 yrs, 100% investment grade (no banks), 5.8% cash|
Two concluding points to note. Firstly, broad Government bond indices have lost over 3% in a couple of weeks, which is quite a lot for what is commonly perceived to be a cautious low risk asset. Indeed, holders of 10-year German Bunds have lost 6% in the same period, or 12 times the annual coupon! Secondly, equities are also falling, so a traditional 50% equity / 50% bond portfolio has provided little in the way of downside protection.
Finally, we note with some interest that the onset of the market’s latest sell-off coincided almost exactly with the resignation of a high profile (UK-based) manager, whose (early) call of a bubble in government bonds had caused his fund to underperform for some time. The decision by his former fund’s new managers to immediately move its duration from -1.7 yrs to 3.2 yrs (i.e. from short to long the market) looks suspiciously to us like “a Tony Dye moment“. And for those who don’t remember who he was, please ask the MitonOptimal team!