Bond Markets - The “safest of assets” could suffer losses we have never seen beforeBen Raven - Director
If we look at historical trends in interest rates there is a likelihood that they could rise by considerably more than 1%.
This trend continues and a 3% move in interest rates would lead to a staggering -29.31% loss, with a yield of 5.04% (the losses taking at least 5.5 years to recoup).
The crucial point to remember here is that clients typically invest in bonds when they are seeking a ‘safe haven’ asset class. Bonds are considered low risk and any client who comes out at the low end of their attitude to risk questionnaire will almost certainly have a significant allocation to bonds within their portfolio. Even more concerning is that as investors approach retirement, the ‘lifestyling’ approach dictates that they are moved out of equities and into bonds as they enter the wealth preservation phase of their life.
The conclusion is that there are millions of investors who are currently invested in bonds who do not have the appetite for this type of risk. These clients include average UK retail clients as well as large-scale pension funds. These are clients who cannot afford to suffer material losses on their portfolios. For them, whether interest rates rise by 1% (-9.77% loss), 2% (-19.53% loss) or 3% (-29.31% loss) the result is the same – a loss far greater than the client can potentially tolerate.
- A greater investment in global bond markets. Exposure to the likes of Emerging Market Debt (both local currency and USD), US and Euro High Yield and US Corporate issuance can provide better risk/reward opportunities for a bond portfolio at present.
- A reduced portfolio duration. High quality, short duration corporate and sovereign issuance will significantly protect clients in a rising inflation/rate environment.
These factors enable clients to access highly sophisticated and robust bond portfolios that offer the potential to achieve positive real returns which cash and traditional bond portfolios/allocations will fail to do over the coming years.
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