For John O’Toole, global head of multi-asset solutions at Amundi, the ability to get a yield of 5 per cent from short-dated government bonds makes him ponder whether “it’s worth going anywhere else” right now for fixed income yield, given the spreads available on assets that carry extra inherent risk either from interest rate movements or the potential for a credit default.
The dilemma is also central to the thoughts of Brian Kloss, fixed income investor at Brandywine, who says: “The narrative around the bond market is changing very rapidly, the topicality is immense. The issue most of the time is whether the central banks are putting the accelerator or the brake pedal down.
"And in the US during the pandemic, they put the gas pedal down, and what we have seen recently in terms of volatility has been a function of the brake being applied."
Usually in the latter stages of the 'brake' being applied, bond investors buy longer-dated bonds, as these usually perform best when inflation and economic growth are both declining.
But this has not been the case of late, as investors have rapidly revised their expectations around the extent and timing of US inflation returning to target.
While such moves enhance the case for diversification within a fixed income portfolio, Kloss says that rather than taking any outsized positions in the name of diversification right now, when people are unsure as to what risks one wants to diversify against, he is instead focusing on owning government bonds.
These are "at the short-end of the curve where the yields are good, and a little bit in the [middle] of the curve" – this part of the curve would be less sensitive to a recession shock than the start of the curve – "and then just wait and see what happens".
Matthew Rees, head of global bond strategies at L&G Investment Management, is of the view that one should always diversify regardless of what asset class is involved, and even if this means occasionally accepting a lower yield.
But he notes that the spread – that is, the difference in the yield level between one type of bond and another – is presently high enough to justify owning bonds with a higher credit risk, as the yields are attractive enough.
He said this may represent some diversification away from government bonds, while also providing a higher income yield for those clients with that as a priority.
Rees says there has been considerable disquiet around the prospects for high-yield bonds due to fears around the implications for the issuers of such debt when they come to refinance at much higher rates, and then default on their obligations.
But he says fears here are overstated, as many of the companies that issue high-yield bond did so during the pandemic and have many years yet to run on those bonds, locked in at low interest rates.
With this in mind, he says there is some value to be had from high-yield bonds as a diversifier right now, particularly as the yields are sufficiently high that they compensate for some capital loss, if the latter occurs.
