The season to be jolly is always accompanied by speculation on the outlook for the year ahead. This year’s ponderings have been relatively diverse, with some economists and analysts believing investors should retreat into comfortable equity income stocks, while others argue it is time to embrace a little risk. However, the pundits seem to be agreed on one key point – steer clear of bonds.
All the well-rehearsed arguments for this have been rolled out – bond yields are at record lows, spreads on corporate bonds have contracted, buyers are finally starting to move towards equities and so forth. The US Federal Reserve meanwhile has explicitly stated it wants to reduce the yield on bonds so yield-hunters are forced into ‘higher risk’ assets and, as many an asset allocator has had cause to reflect, ‘you don’t fight the Fed’.
But there are more esoteric arguments against bonds as well – for example, liquidity in bond markets is now becoming a serious issue. There is increasing speculation some of the larger bond houses could have real problems unwinding their positions in the event of a market panic and significant outflows. Being a forced seller of large holdings in an illiquid market is a toxic cocktail for any manager.
Of course, there are solid arguments against this – not least that, while gilts may be expensive, they are not price-sensitive because so many people have to buy them. Any immediate back-up in yields therefore looks extremely unlikely. But it does suggest investors ought at least to be thinking about alternatives.
And there are some around. Commercial property, for example, remains widely unloved but, at some point, investors will stop punishing it for the bubble of 2007 and revisit the asset class. After all, it is designed to do exactly what bonds do – deliver a predictable, low-risk income stream. Funds in the IMA Property sector have delivered 11.1% this year and, in many cases, are still paying a respectable 3% to 4% yield. Certainly, commercial property has pressure points but it is becoming a forgotten asset class.
Infrastructure funds have also been a popular choice among fund-of-funds managers seeking to diversify away from the bond arena. There is an increasing choice in this part of the market as investors have come to appreciate the long-term, inflation-protected income streams on offer. Equally, within the investment trust sector, there are niche investment options paying a bond-like income stream. The Thames River Multi-Capital team hold, for example, the MedicX investment trust and the Darwin Leisure Property fund.
In other words, investors still have options. They can move away from the bond market and the complexities therein while generating a similar return profile. These may ultimately be arbitraged away but, for the time being, they are still available.
Important Note: Material within this article has been complied with the help of the Marketing Hub which is part of Marketing In Practice Ltd on behalf of your professional financial adviser. The contents of this document do not constitute advice and should not be taken as a recommendation to purchase or invest in any financial product. The value of a market investment can go down as well as up and you may not get back the full amount, particularly in the short term. Before taking any decisions, we suggest you seek advice from a chartered financial planner.