With the prospect of looming interest rate hikes around the world, investors are turning their attention to short-dated bonds.
Matthew Russell, a retail fixed-interest fund manager at M&G, said an increasing number of clients were looking at the asset class.
‘Higher interest rates are bad news for bonds,’ he said. ‘How bad they are will be determined by the duration.’
Russell said clients who worried about higher rates and needed an allocation to fixed income wanted somewhere to hide, until it was safe to return to traditional corporate bond funds.
‘Traditionally, the downside with short-dated bonds is that, over time, the longer you lend for, the more yield you get,’ he said. ‘Lending for a shorter period of time will give you lower yields. That is still the case.’
Russell also believes the strength of the UK consumer is going to be a deciding factor when it comes to the possibility of future interest rate hikes by the Bank of England.
‘It looks as though people have dipped into their savings and are also borrowing more,’ he said. ‘There’s maybe more debt than a year or two ago.’
Michael Count, Citywire + rated co-manager of the CF Canlife Short Duration Corporate Bond fund, believes it is the start of a global economic recovery and monetary tightening cycle.
‘This will put upward pressure on interest rates and bond yields,’ he said. ‘Short-dated bonds offer investors more protection against these increases, as they are shorter in duration.’
Count insisted he was still able to find high quality securities that can deliver attractive yields in this environment, but pointed out returns could vary. If the economy entered a recession and monetary tightening was put on hold or even reversed, short-dated bonds would be unlikely to fall in value. ‘But investors may make greater returns in longer-dated bonds,’ he said.
Although Count expects all central banks to tighten in a careful and gradual way, he pointed out the tide had shifted, with rates having risen in the US, Canada and the UK. He believes short-dated bonds will be quite resilient to rising interest rates but warned that credit problems, such as defaults or restructurings, could be damaging.
‘Just one company getting into problems has the ability to wipe out a whole year’s income, even in a well-diversified fund,’ he said. As a result, he focuses on good quality investment grade bonds and uses internal credit research, rather than relying on ratings agencies.
Sajiv Vaid, portfolio manager of the Fidelity Short Dated Corporate Bond fund, heavily favours investment grade bonds in the one-to-five-year range.
‘The fund is for the more conservative investor. They may be looking for really modest income, but capital preservation is the key,’ he said.
Potential risks are also mitigated by sector allocation. ‘We are underweight in the banking sector because the volatility as capital preservation is crucial,’ he said. ‘Despite the good run of financial bonds, it’s an area to be concerned about.
‘For us, a short-dated fund is really about identifying the right bond and locking it in,’ he said. ‘That’s what we’re aiming to deliver to our clients.’