Bond Apocalypse Now: Is the end nigh for bond investment as M&G reveals high levels of outflows in its most recent results?

 
Laith Khalaf
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Is the end nigh for bond investment? (Source: Getty)

The UK bond market is sitting on a bed of nitroglycerine, according to Bill Gross, one of the world’s most pre-eminent bond investors. Or at least, that was his prognosis in January 2010, since which time UK government bonds have returned over six per cent a year and yields on the benchmark 10 year gilt have fallen from four per cent to 1.5 per cent.

To be fair to Gross, he was not a lone voice in the wilderness. Plenty of sensible managers and commentators have predicted the bond apocalypse over the last six years, and for good reason.

With bonds at such high prices, there is a large risk to capital and little in the way of return to compensate. But despite the logic, this point of view has been repeatedly confounded by the bond market going from strength to strength.

However, in 2015, UK retail investors appear to have woken up to the risks inherent in bonds. Since May of last year, they have withdrawn £1.4bn from fixed interest funds. One of the casualties of this new trend was M&G, a company with a successful and well-regarded bond team, which saw fund outflows of £10.9bn over the year, across retail and institutional clients.

The US interest rate hike in December was no doubt partly responsible for the shift in sentiment towards fixed interest markets. While small, it was nonetheless a meaningful moment in that it signalled a change of direction in monetary policy in the world’s most influential economy.

2015 was also the first calendar year since 2008 in which the corporate bond and strategic bond sectors registered a negative return. This may have prompted some investors to take profits in anticipation of a wider sell-off.

This may be some way off yet though. Deflationary pressures are exerting their influence across the globe, and this is supportive of bond prices. Likewise stock markets are febrile which tends to leave investors seeking the relative safety of bonds. We shouldn’t entirely ignore the actions of Messieurs Draghi and Kuroda either; both European and Japanese central banks are pumping billions of pounds into bond markets each month, and have taken interest rates below zero.

Against this background it’s hard to see a catalyst for the bond apocalypse. At some point bond prices will have to come back down to earth. But whenever central banks finally decide to raise interest rates in earnest, they will do so slowly and gradually. The bubble may therefore simply deflate, rather than exploding in world-ending fashion.

City A.M.'s opinion pages are a place for thought-provoking views and debate. These views are not necessarily shared by City A.M.

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