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'Bond bubble' dismissed as fears turn to emerging markets

One of the UK’s most successful bond managers dismisses warnings of a bond market bubble.

'Bond bubble' dismissed as fears turn to emerging markets

One of the UK’s most successful bond managers has dismissed warnings of a bond bubble, saying equity investors’ obsession with the death of the bond market last year was only rivalled by their excitement over the bestselling book 50 Shades of Grey.  

Countering repeated claims of the ‘death of the bond market’ as yield-hungry investors rotate into equities, Kames Capital bond fund manager Philip Milburn said ‘we’ve all been through bubbles before. Government bonds are undoubtedly expensive. They’ve been rigged by central banks. Is that a bubble or is it monetary policy?’

Warnings over the threat of a bond bubble have been circling for the last few years, but have reached fever pitch recently amid speculation that central banks could soon scale back their policies which are suppressing interest rates.

Bond prices usually move in the opposite direction of interest rates. When interest rates fall the fixed interest on bonds looks attractive and their prices rise. When interest rates rise, the fixed income from bonds does not look so good and their prices fall.

Milburn was confident that the US Federal Reserve would not end its quantitative easing bond buying programme anytime soon, pointing to the Fed’s plan to keep interest rates low until unemployment falls to 6.5%. ‘Until unemployment comes down to below 6.5% there is no chance of rates going up in Bernanke’s term,’ he said.

‘We’re virtually where we were at start of 2012. Government bonds are expensive but while monetary policy needs to stay very loose they are likely to stay expensive,’ he added.

While plenty of investors disagree, Fidelity Worldwide’s chief investment officer of fixed income Andrew Wells, recently made a similar point, when he said the macroeconomic environment will continue to support inflated prices.

But other investors aren’t so confident. Some fund managers are so worried that they’ve stayed away from bonds and chosen to invest in low-yielding cash – at the expense of higher returns. Richard Peirson, the Citywire A-rated manager of the AXA Framlington Managed Balanced fund, told Citywire before Christmas that he had maintained a larger position in cash than bonds throughout 2012.

Few would argue that G4 government bonds are over-priced. ‘Gilts are a no-brainer. Why hold something where risk must be sooner or later that there’s a sell-off,’ said Tom Elliott, global strategist at JPMorgan asset management, this morning.

Many investors have instead poured their cash into government bonds issued by emerging market governments. But according to Milburn and Kames Capital colleague David Roberts herein lies the real danger. ‘This is one part of the market that continues to give us cause for concern. Concerned investors bought into what is now a crowded market. There are quite significant signs of balance sheet repair in emerging market economies, but the geopolitical risks are understated,’ said Roberts.

The pair still think investors can profit from investment grade corporate bonds, after strong gains last year, particularly those issued by financial companies. ‘Financial bonds remain v attractive – one of the better ways of adding value as we go through 2013,’ said Roberts. ‘Investment grade remains very much at the core of our portfolios.’

High yield corporate bonds, those that have lower credit ratings, still offer promise too, according to Roberts: ‘Though high yield has had very good couple of years, the market is suggesting there is still some more to go for high yield total returns…. defaults should remain quite low and there is a huge need and demand for income and yield.’

The funds Roberts and Milburn manage include the Kames High Yield Bond fund , a Citywire Selection Star Pick which has returned 44% over the past three years, compared to the average return of 32% generated by similar funds run by competitors. 

6 comments so far. Why not have your say?

Chris Clark

Jan 09, 2013 at 15:38

Not sure I agree the view at all. There's a definite trend downwards in US 5 year Treasury prices on my screen here, though admittedly lots of volatility.

Perhaps a fiscal cliff or 10 is needed to give bond investors reassurance!

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Jan 09, 2013 at 23:18

Turkeys saying Christmas will never come?

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William Bishop

Jan 12, 2013 at 09:38

Maverick's comment is appropriate - US, UK, German, French treasuries are rotten value on a long term view, even if still supported by central bank buying in the shorter term. The original commentary could, however, be right that there is more short-term risk to those who have been pushing the envelope too far in search of a decent yield, something that has often proved a dangerous tactic. Equities are usually a better way of seeking a higher return than high-yielding bonds, which only offer a capped return that may not provide adequate risk compensation in normal circumstances. (though proved a good bet in the abnormal conditions of 2008/09)

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Jan 12, 2013 at 10:21

This article is more hedged about than my gran' s garden.

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Chris Clark

Jan 12, 2013 at 11:06

@William Bishop

Supporting your view, US 5 Yr T bond prices (not yields) are showing a 6 month gentle trend downwards, with some volatility, and recent sudden downward lurches and recoveries.

Does seem to have a feel of direction now.

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masud butt

Jan 12, 2013 at 19:56

I am retiree, I am adding Bonds, but not Gov, bonds but Co-op , High Yield,& high Grade and EM Bonds, I also invest in global high income Equity funds, 50/50. Any comment please, Thanks

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