Our views

Dealing with yields at record lows

Jonathan Platt, Head of Fixed Income

14 October 2016

We’ve seen yields fall sharply in recent months as the Bank of England announced a rate cut and further quantitative easing. This has meant strong returns from bonds – gilts have returned some 12% over the 12 months to the end of September, while index-linked bond holders have seen gains of 24%.

With yields on the ten-year gilt around 1%, investors are concerned about the possibility of capital losses if bonds return to ‘normal’ levels. Many have been negative about the prospects for yields for some years, but while QE continues and there is pessimism about future economic growth, we firmly believe that there will be no return any time soon to the 4%-plus levels that we saw prior to the financial crisis. However, we do expect yields to rise from current ultra-low levels.

This is not a new view – in fact it’s one we’ve had for some time, and is the reason we have been short duration on a strategic view across our gilt and credit portfolios. In anticipation of a turn in yields RLAM have developed a range of short duration bond funds, with the first of these launched in 2013. This range of six strategies – covering government bonds, index-linked, corporate bonds and high yield –  has seen a pickup in cashflows in recent months ( particularly short duration credit and short duration high yield) and now has  well over £1 billion in assets. Short duration bonds have a number of advantages in today’s market – lower volatility, greater liquidity and attractive income. They also tend to have lower correlation with the rest of the fixed income universe, thanks to that lower interest rate sensitivity.

Talking to our clients, fixed income still has a vital role to play in meeting investor needs. However, the threat of yields rising from historically low levels will continue to put many off. Given that we expect to be a correction that will take place over an extended period, a strategic allocation to short duration strategies is worth considering.

The value of investments and the income from them is not guaranteed and may go down as well as up and investors may not get back the amount originally invested. The views expressed are the author’s own and do not constitute investment advice.