View the article online at http://citywire.co.uk/money/article/a684024
Bond funds lose money. How bad could it get?
Bond funds lost money last month amid the uncertainty over the US Federal Reserve's stimulus policies. Has the tide finally turned?
In the past two weeks uncertainty over how quickly the US will scale back its stimulus policies has unsettled investors, creating what wealth manager Rowan Dartington calls the ‘perverse scenario’ in which both bond and equity markets have fallen.
Since 22 May when Federal Reserve chairman Ben Bernanke indicated the central bank was considering when to start reducing the huge level of quantitative easing, or money printing, it provides each month, the FTSE 100 has fallen nearly 4%.
Meanwhile, in the past month the yields on the UK’s 10-year government bonds (gilts) have jumped from below 1.65% to just over 2% as investors have dumped the stocks, causing their price to fall.
Not everything has fallen though, by any means. The latest funds data shows that Guinness Alternative Energy was the best performer in the past month (3 May to 4 June), soaring 13.6%. The fund, run by Citywire A-rated Edward Guinness and Matthew Page, remains 48% down over three years, however.
Funds investing in smaller US companies also did well with Fleming Family and Partners, Legg Mason and JPM scoring gains of over 8%. The Fleming and JPM funds have also done okay over three years with gains of over 30%.
But as often in these nervous markets it is the losers who grab the most attention.
Last month's turkeys
The specialist JPM Turkey Equity fund has slumped nearly 13% in the past month as protests against prime minister Erdogan grew, undermining the confidence of investors who may have reckoned it was time to take profits on an emerging market that has soared in recent years.
Asian property funds that have benefited from the enormous liquidity that Japan has pumped into its stock market since April, tumbled at the prospect that the largesse could fail to prevent interest rates from rising. The Henderson HF Asia Pacific Property Equities fund slid over 11%, followed by First State Asian Property Securities down nearly 10%.
The Junior Gold and Ruffer Baker Steel Gold funds matched these falls as investors took the view that a reduction in money printing by the US Fed would further undermine the attractions of the precious metal, and the mining companies that dig it out of the ground.
Bond funds get battered
But the real story lies further down the list of fallers.
As the Financial Times yesterday reported, bond funds have had a testing time as investors have panicked that whatever the Fed decides to do, the game may be over for bonds. The bull market in bonds, as Pimco’s Bill Gross and others have recently declared, looks to be over if the US economy is strengthening and if the extraordinary gamble of QE enters its end game.
Unsurprisingly, the higher risk end of the bond spectrum was hardest hit.
Emerging market bond funds from the likes of First State , Pimco , Investec,Legg Mason and Barings fell between 4% and 7% last month as investors turned their attention back to the US and the strong dollar.
Closer to home, funds investing in longer maturity bonds took a similar hammering. This was entirely predictable. Bonds do badly when interest rates rise, making their fixed levels of interest unattractive. Those with longer duration – or a higher exposure to interest rate rises – do worst of all, as AXA’s Theo Zemek yesterday reminded us when she recalled how government bond funds were smashed in 1994, when interest rates rose unexpectedly.
This is why bond fund managers have been cutting duration as much as they can in order to protect investors. But even the M&G Strategic Corporate Bond fund, a popular fund managed by Richard Woolnough (pictured) which has a flexible ‘whatever it takes’ policy within it’s the asset class, lost 2% last month. The fund is a favourite of our Citywire Selection team and lies second in its sector over five years with a 77% total return.
Has the tide finally turned against bond funds?
We’ll hear what Woolnough, who received his last Citywire performance rating nine months ago, has to say tomorrow when we join a webcast with the fund manager. It will be really interesting to hear what he has to say.
But there is no doubting that investors are nervous.
Mark Burgess, chief investment officer at Threadneedle Investments, has said the group has started to ‘reduce our large overweight in investment grade credit’.
The price of the high quality corporate bonds he refers to are linked to the prices of developed market government bonds. As these government bonds have soared in response to the immense QE buying power of the Fed and the Bank of England, they have taken corporate bonds with them.
Investors such as Burgess fear a bubble has formed and that the recent sell-off is an indication of how markets might respond to the gradual withdrawal of QE and the eventual rise in interest rates.
Opinion is divided as to what the Fed will do and when it will act. Russ Koesterich, global chief investment strategist at BlackRock, believes the US economy is not so robust and that the Fed will not seek to stop QE and raise interest rates until next year at the earliest. He and everyone else will be watching the next US jobs figures on Friday with interest.
If true, this may give bonds more time but the market does appear to be running out of road.
'Lose, lose' for government bonds
In a report this week Swiss investment group Pictet Asset Management said investors in government bonds were in a 'lose, lose situation' over the next few years.
'Should growth accelerate at an unexpectedly sharp pace, yields will inevitably head higher from their historically low levels' [and bond prices will therefore fall]. 'Should the opposite occur and business conditions deteriorate, the likely response from policymakers – a further round of monetary stimulus – can be expected to fuel concerns about inflation' [which bonds hate].
This then raises the issue of whether investors should get out of the asset class entirely or seek pockets of safety and good value. The trouble is lower quality, high yield corporate bonds and emerging market bonds are expensive too. Higher volatility and lower returns look inevitable over the next few years.
Luca Paolini, Pictet's chief strategist, favours emerging market bonds on a five-basis, arguing the fundamentals are favourable given the relatively healthy financial state of their economies. However, their short-term prospects look cloudier if investors continue to withdraw their money at the current rate, attracted by the strong dollar, and discouraged by the threat of something nasty in China.
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Look up the funds
- Guinness Alternative Energy B
- JPM Turkey Equity A Acc EUR
- Henderson HF Asia-Pacific Property Equities A1 USD
- First State Asian Property Securities A GBP Acc
- Junior Gold Ret
- CF Ruffer Baker Steel Gold O Acc
- M&G Strategic Corporate Bond A Inc
- Baillie Gifford Japanese Smaller Companies A Acc
- Threadneedle Japan Smaller Cos Ret Net Acc GBX
- First State Emerging Markets Bond I
- PIMCO Emerging Markets Bond Fund;Institutional
- Legg Mason WA Emerging Markets Bd A Acc USD
- Baring EM Debt Local Currency A GBP Hedged Inc
- FF & P US Small Cap Equity
- JPM US Smaller Companies A Acc
- Legg Mason US Smaller Companies A
Look up the fund managers
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by Daniel Grote on Jun 30, 2016 at 17:37