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Fixed income update – volatility in the bond market

Joseph Hill, Investment Analyst, looks at the impact of the coronavirus pandemic on fixed income markets.

Important notes

This article isn’t personal advice. If you’re not sure whether an investment is right for you please seek advice. If you choose to invest the value of your investment will rise and fall, so you could get back less than you put in.

Governments around the world are encouraging us all to stay at home. This means no pub or cinema trips, and no daily commute to and from work, all in a bid to slow the spread of coronavirus.

The measures are likely to cause a big fall in consumer spending, which is an important component of gross domestic product (GDP), acting like a brake on the economy, and increasing the chances of a recession. Change in GDP over time is the most commonly used measurement for economic growth. And historically, credit spreads have been closely correlated with economic growth.

Credit spreads are the differences in yields between two bonds of different quality that have the same or similar maturities. Government bonds, like a 10-year gilt, are usually used as the benchmark.

When economic growth weakens, credit spreads tend to widen. It’s usually a sign investors are worried about companies being able to service their debt.

For some companies there might only be a short-term impact. Once things get back to normal they could see a big uplift from customers flooding back all at once. But for others, there might be a deeper, longer lasting impact. If you’ve frozen your gym or leisure club membership, for example, that’s lost revenue that those businesses might not be able to recoup.

This article isn’t personal advice. If you’re not sure if an investment is right for you please seek advice. Past performance isn’t a guide to the future and all investments including the income they produce can fall as well as rise in value so you could make a loss. Unless otherwise stated data is correct as at 20 March 2020.

A sizeable Fiscal and Monetary response

We’ve seen governments and central banks react to the threat to economic growth across the globe. Even producing a more co-ordinated approach than we saw during the global financial crisis of 2008.

Government responses have centred on three main areas. The first is increased healthcare spending in an attempt to contain and treat coronavirus. The second is help for companies facing business disruption and finally, maintaining employment and income of impacted workers.

A consequence of the scale of some interventions will be ballooning government deficits and much higher levels of government debt. In the words of Chancellor Rishi Sunak, governments are doing “whatever it takes” to control the impact of the virus on people’s health and wealth.

We’ve also seen strong and decisive global monetary action from lots of central banks. The US Federal Reserve has implemented an emergency rate cut to a target range of 0%-0.25%. This has been combined with an initial $700bn of quantitative easing (QE), and there could be more to come. The Fed’s measures even include a historic step to buy corporate debt.

QE involves central banks creating money to then buy assets like government bonds back from institutions like banks. It should encourage the banks to lend and increase the amount of money in circulation, giving a boost to the economy.

In the UK, the Bank of England announced a further £200bn of QE while cutting interest rates to just 0.1%, the lowest rate in the bank’s 325-year history.

Ariel Bezalel, manager of the Jupiter Strategic Bond fund recently shared his thoughts on how markets have reacted so far:

‘’This is a black swan event that has taken a lot of market participants by surprise, causing an acute re-pricing of risk. Risk assets have rallied on some days, but we see this as a serious risk-off environment. Markets have reacted badly to the measures announced recently, with credit spreads moving wider and equity markets down. The Fed have gone all in, but instead of feeling reassured the market instead seems to be thinking ‘what do they know that we don’t know’? Also, the market could well be getting concerned that Central Banks are now 'tapped out'."

Hargreaves Lansdown may not share his views.

How have bonds performed?

Much of what investors have taken for granted has recently been turned upside down.

Over the past decade, stock markets have delivered handsome returns. But things aren't quite the same so far this year. By market close on 23 March the FTSE World Index is down more than 20%, and some markets have suffered even steeper losses. The UK's FTSE All Share has lost 34.3%.

Bond markets have acted a little differently. Until the beginning of March they generally held up well, particularly government bonds from the US and UK.

It's unlikely for developed market governments to fail to pay back their debts, so in times of uncertainty they're seen as one of the safest areas of the fixed income markets. A weaker economic growth outlook, combined with interest rate cuts from the US and UK central banks, saw investors favour these bonds. This pushed their prices up but their yields down. US 10-year treasury yields recently hit a record low.

US 10-year treasury yields – 31/12/19-20/03/20

Scroll across to see the full chart.

Past performance is not a guide to the future. Source: Eikon to 20/03/2020

We'd normally expect bond yields to stay low when there's so much uncertainty about. But there have been some huge swings in the market, and yields actually bounced back during the first few weeks of March.

We believe this happened partly because investors in need of cash were selling investments from some of the most liquid parts of the market. Liquidity is a measure of how easy it is to buy and sell an asset. In the recent environment, liquidity has been tight, making it harder for investors to sell at an acceptable price. As a result lots of investors looked to more liquid investments like US treasuries to raise cash. This put pressure on bond prices causing them to fall, which in turn caused yields to rise.

What about the corporate bond markets?

At a broader level, investment grade bonds, which are higher-quality and issued by companies in better financial shape, have done slightly less badly than high-yield bonds. High-yield bonds are issued by companies that are less likely able to pay off their debts. They tend to do worse in turbulent markets because of their higher-risk nature.

Liquidity has also been quite thin in high-yield markets, so if investors are forced to sell their investments in order to raise cash, they're more likely to take a cut on the price they get. This has also put pressure on bond prices.

US high yield bonds, which make up a significant part of the global high yield bond market, have also suffered from falling oil prices. Energy companies and shale gas providers, which make up a large part of the market, have been weak.

The travel and leisure sectors have also taken a big hit, but the virus is impacting every part of the market to some degree. This is quite different to the 2008 financial crisis, when banks bore the brunt of the market falls. In fact, this time around banks are better capitalised – they generally have lower proportions of debt and should be in a better position to support economies.

Currency movements also have a big impact on bond market performance. The US dollar has been very strong, while sterling, which in recent years has tended to fall relative to other major currencies on bad news, has been weak.

Weaker sterling’s benefited UK investors in overseas bonds, especially those denominated in US dollars. On the other hand, US dollar strength has been bad for emerging markets currencies and local currency emerging markets bonds. In particular this could be damaging for companies that have previously borrowed money in US dollars.

Bond markets aren’t keeping still and yields have fallen again in recent days. Over the short term we're likely to see further swings in the market. But it's ultimately a fruitless endeavour trying to predict what might happen day to day, especially as coronavirus, an unpredictable force, is dictating so much of what investors do.

In the long run it's widely expected the bond bull run will come to an end. Firstly, that's because bonds arguably don't offer much value at the moment after performing well for so many years. Secondly, central banks across the globe are implementing huge economic stimulus packages. These policies are broadly expected to be inflationary, which typically keeps bond yields higher – investors will look for returns above the speed at which prices of everyday goods are rising.

We don't see the rally being cut short just yet though. There are deflationary forces at play – falling prices could keep bond yields lower, at least in the short term.

This is partly because we have a growing, elderly population. In recent years, this has driven demand for income and perceived "safe-haven" investments, such as bonds, pushing up their prices and down their yields. With income scarce from other sources, this demand could be set to continue.

Consumer goods prices have also remained subdued, inhibiting inflation. The rapid pace of innovation has driven down the cost of technology-related products, and the internet allows us to find any product at the cheapest price available.

Innovation and technology help businesses operate more efficiently, keeping costs and consumer prices down. There’s also little reason for businesses to raise prices in the current environment, given many shops are now closed. There’s also likely to be little demand from people in lockdown.

Going forwards, it's impossible to know the full impact of the virus on both global economies and bond markets. The situation is extremely fluid, and the impact on markets can change rapidly. That said, if we are on course for a global recession, government bonds could remain a place to be as part of a diversified portfolio. They also remain a good diversifier against equities, which are likely to remain volatile, especially in the short term.

The risk of fallen angels

One concern for investors is likely to be the potential for an increasing number of fallen angels. These are bonds that were previously labelled the highest quality (investment grade) but end up being downgraded to lower quality high-yield ratings.

There can be a number of reasons why a bond might fall into this category, but it’s usually driven by a decline in revenues. This makes it more likely that the company that issued the bonds won’t be able to pay the interest due. And the more debt a company has, the more quickly this is likely to become a concern. It’s clear the restrictions needed on consumer activities in response to the coronavirus outbreak are going to hurt airline, travel and leisure companies – there’s a risk their bonds might be downgraded.

In the 12 months leading up to a downgrade, fallen angel bond prices have been much more volatile than other bonds that are downgraded within the investment grade label – those that stay investment grade don’t fluctuate as much, despite being downgraded. If a downgrade pushed a bond down in to the high yield category, selling pressure could rise. Particularly if some investors, like fund managers who have to hold a minimum percentage of assets in investment grade bonds, are forced to sell as a result.

Remember this article isn’t personal advice. All investments can fall and rise in value so you could get back less than you put in. If you’re not sure what to do, please ask for advice.

Wealth 50 Review

Corporate Bonds

There are a few different types of bond funds on the Wealth 50, and each sector invests differently. Corporate bond funds usually invest in bonds issued by companies. Yields can be higher, but these funds are generally higher risk than those that invest more in government bonds. The funds throughout this article aren’t suitable for all investors.

Fidelity MoneyBuilder Income has been the best-performing Wealth 50 fund in the corporate bond sector since the turn of the year, outperforming the wider corporate bond peer group. The fund invests relatively conservatively so we’d expect it to hold up better than other bond funds when times are tough, though it has still fallen in value.

Although over the long term the Morgan Stanley Sterling Corporate Bond fund has delivered strong returns for investors, it’s been the worst performer since the start of the year – underperforming its peers over this short time period. Please remember past performance isn’t a guide to the future.

Recent performance

Fund 31/12/19 - 20/03/20 Key Investor Information (KII)
Fidelity MoneyBuilder Income -5.6% KII
Morgan Stanley Sterling Corporate Bond -9.3% KII
Royal London Corporate Bond -7.1% KII
IA Sterling Corporate Bond -8.7%

Past performance is not a guide to the future. Source: Lipper IM to 20/03/2020

Five year performance

Annual percentage growth
Mar 15 -
Mar 16
Mar 16 -
Mar 17
Mar 17 -
Mar 18
Mar 18 -
Mar 19
Mar 19 -
Mar 20
Fidelity MoneyBuilder Income -1.5% 6.8% 1.7% 2.5% -0.7%
Morgan Stanley Sterling Corporate Bond -0.3% 8.1% 2.9% 2.8% -3.8%
Royal London Corporate Bond -1.8% 9.0% 3.4% 2.9% -1.6%
IA Sterling Corporate Bond -1.1% 9.0% 2.3% 2.9% -3.5%

Past performance is not a guide to the future. Source: Lipper IM to 20/03/2020

High income

Funds in this sector aim to pay a high income to investors and can own different investment types, including both shares and bonds.

Both our Wealth 50 options within the high income sector have struggled so far this year. High-yield bonds have had a tough time, particularly those issued by companies that are more sensitive to the economic cycle. Shipping and travel companies have been among the hardest hit by the effects of the coronavirus pandemic. Additionally, the fallout of the dispute between Russia and Saudi Arabia over oil production, on top of the coronavirus related uncertainty, has sent oil prices tumbling. It’s hit an energy sector that makes up a big chunk of the high-yield space.

Eric Holt, manager of Royal London Sterling Extra Yield Bond and Alex Ralph, manager of Artemis High Income have delivered strong outperformance over the long term. We think they have the experience to navigate uncertain markets, although past performance isn’t a guide to the future.

Recent performance

Fund 31/12/19 - 20/03/20 Key Investor Information (KII)
Artemis High Income -17.8% KII
Royal London Sterling Extra Yield Bond -17.0% KII
IA Sterling Strategic Bond -9.9%

Past performance is not a guide to the future. Source: Lipper IM to 20/03/2020

Five year performance

Annual percentage growth
Mar 15 -
Mar 16
Mar 16 -
Mar 17
Mar 17 -
Mar 18
Mar 18 -
Mar 19
Mar 19 -
Mar 20
Artemis High Income -2.3% 11.4% 5.4% 0.6% -13.2%
Royal London Sterling Extra Yield Bond -0.6% 17.4% 8.9% 4.8% -11.9%
IA Sterling Strategic Bond -1.1% 8.4% 2.5% 1.8% -4.8%

Past performance is not a guide to the future. Source: Lipper IM to 20/03/2020

Strategic and global bonds

Strategic and global bond funds tend to have the most flexibility in where they can invest. Our Wealth 50 selections in the strategic and global bond sectors have performed strongly since the start of the year, outperforming their respective sectors by a comfortable margin.

The strongest performer on the list in the strategic bond sector has been Invesco Tactical Bond, co-managed by the vastly experienced fixed income duo Paul Read and Paul Causer, though it has still fallen in value. The managers have had a cautious economic outlook for some time so had positioned the fund conservatively with a high allocation to government bonds and short-term corporate bonds.

The M&G Global Macro Bond fund, managed by Jim Leaviss has had an extremely strong start to the year in comparison to its peers and is the only fixed income fund that features on the Wealth 50 that’s in positive territory. Leaviss, too, was cautious heading into 2020, building big positions in government bonds and positioning the fund with a long duration, so that if interest rates fell the fund would benefit. Of course, this is what’s happened and it’s resulted in excellent relative performance over this short timeframe. Please remember past performance isn’t a guide to the future.

Recent performance

Fund 31/12/19 - 20/03/20 Key Investor Information (KII)
Artemis Strategic Bond -7.1% KII
Invesco Tactical Bond -4.4% KII
Jupiter Strategic Bond -5.0% KII
IA Sterling Strategic Bond -9.9%
z

Past performance is not a guide to the future. Source: Lipper IM to 20/03/2020

Fund 31/12/19 - 20/03/20 Key Investor Information (KII)
M&G Global Macro Bond 8.5% KII
IA Global Bonds -2.4%

Past performance is not a guide to the future. Source: Lipper IM to 20/03/2020

Five year performance

Annual percentage growth
Mar 15 -
Mar 16
Mar 16 -
Mar 17
Mar 17 -
Mar 18
Mar 18 -
Mar 19
Mar 19 -
Mar 20
Artemis Strategic Bond -0.8% 10.0% 5.1% 0.7% -2.6%
Invesco Tactical Bond -1.0% 4.5% 1.3% -0.4% -1.2%
Jupiter Strategic Bond -1.0% 8.5% 1.8% 2.8% -0.1%
IA Sterling Strategic Bond -1.1% 8.4% 2.5% 1.8% -4.8%

Past performance is not a guide to the future. Source: Lipper IM to 20/03/2020

Annual percentage growth
Mar 15 -
Mar 16
Mar 16 -
Mar 17
Mar 17 -
Mar 18
Mar 18 -
Mar 19
Mar 19 -
Mar 20
M&G Global Macro Bond 2.9% 18.1% -6.9% 6.4% 12.5%
IA Global Bonds 2.3% 13.2% -1.2% 3.5% 1.3%

Past performance is not a guide to the future. Source: Lipper IM to 20/03/2020


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    Important notes

    This article isn’t personal advice. If you’re not sure whether an investment is right for you please seek advice. If you choose to invest the value of your investment will rise and fall, so you could get back less than you put in.

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