So if gilts are to be a more volatile asset class, albeit one with the potential to deliver outsized returns in the short-term, does that materially impact the structural reasons for owning gilts in portfolios?
Not according to Simon Evan Cook, who runs the Downing Fox range of multi-manager funds.
His view is that gilts are more investable now than “they have been for many years”, as a result of yields being higher.
He says the traditional reason to own gilts in portfolios is to have an asset class that can rise when equities fall.
Evan Cook believes that with yields now high enough, it is reasonable to expect this would happen in the event of a recession, as investors would buy gilts, rather than equities, as a safe haven.
He feels that inverse correlation had broken down for much of the previous decade, as both bond and equity prices were high at the same time, creating a period of time when the structural reason to include gilts in a portfolio made little sense.
His view is that gilts are supposed to be volatile so long as the volatility means they fall when equities are rising, and vice versa.
Ben Seager-Scott, head of multi-asset investment funds at Evelyn Partners, says: “Their structural role remains largely unchanged despite the volatility and the shifting resulting allocations – I think it is important for people to make sure they have a good working understanding of the asset class and its characteristics.
"In particularly, an overlooked aspect is correlation. A lot of people simply assume the correlation between equities and gilts is negative but the reality is it changes over time. Crucially, correlation tends to be negative during growth shocks, but positive during inflation shocks, as we saw last year, to quite painful effect”
He believes the reason gilts performed poorly in 2022 alongside equities, which is not supposed to happen if the asset classes are inversely correlated, is that the bear market in equities was caused by higher inflation, which is also poor for gilts.
But that the next period of equity market sell-off could be sparked by fears of recession, rather than inflation, and in such circumstances, the normal expectation is that gilts would rise when equities fall.
Andrew Hardy, who runs multi-asset portfolios at Momentum Global Investment Management, says the sharp falls in government bond prices generally, and gilts in particular, in 2022 mark a “healthy reset” in terms of valuations, and probably means that the risk to reward ratio is now set firmly in the buyers' favour.
Inflated expectations?
Both Seager Scott and Evan Cook believe that while the yields on gilts are right now still lower than the prevailing rate of inflation, meaning the yields are negative in real terms, they feel that what matters more for the future direction of gilt prices, is the expectation on the direction of future inflation.
