A new bond-age?
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A new bond-age? a presentation by Darren Ruane Senior Bond Strategist. Objective of the presentation. Review the UK government bond market Examine the investment merits of inflation-linked bonds Should investors retain overweight positions in corporate bonds?.

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A new bond-age? a presentation by Darren Ruane Senior Bond Strategist

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A new bond-age?

a presentation by

Darren Ruane

Senior Bond Strategist


Objective of the presentation

  • Review the UK government bond market

  • Examine the investment merits of inflation-linked bonds

  • Should investors retain overweight positions in corporate bonds?


Returns from the Sterling bond market over the past year

Source: Bloomberg, Rensburg Sheppards


UK 10 year gilt yield over the past year


UK 10 year gilt yield: 1990-2010


Challenging outlook for UK government bonds

  • Large level of new supply (£800bn→ £1,400bn)- outlook for UK government finances is challenging

  • Fears over the UK losing its AAA credit rating

  • Fears over gilt demand now that QE has finished

  • Medium term inflation could be much higher than recent historic trends

  • Are we experiencing a V-shaped recovery?

  • Potential weakness in gilts ahead of the UK General Election?


Some gilt exposure should be retained in a balanced portfolio

  • Gilt weakness is the consensus trade

  • Growth and inflation should be subdued if the spare capacity argument is correct

  • Slower than expected economic growth over forthcoming years

  • Continuation of Quantitative Easing programme in the future?

  • Forced buyers of gilts

  • Portfolio insurance


The investment merits of inflation-linked gilts

  • ILGs are a useful tool for bond investors

    (best environment = stagnant growth + high inflation)

  • Inflation protection is very expensive currently

    (see breakeven inflation chart)

  • Some exposure should exist in client’s portfolios

    (100% = default position)


10 years real yield: 1992-2010


UK 10 yr breakeven inflation rate:

1992-2010


Do purchase opportunities still exist in corporate bonds?

  • Returns more influenced by government bond returns

  • Some relative attractions still exist (particularly compared with history)

  • Choice of credit is very important

  • Some interesting opportunities in certain sectors e.g. subordinated financial bonds

  • Watch out for liquidity

  • Corporate bonds still represent attractive investments, especially with cash rates so low


Global high yield default rate

Source: Moody’s


UK credit spreads: 2005-2010


Conclusions: A new bond-age?

  • We enjoyed a benign economic environment between 1997 and 2007 (NICE decade) with gilt yields of 4-6%

  • Going forward, there is likely to be much greater volatility in economic growth and inflation, which should increase the risk premium on bonds

  • Government bonds are likely to face the harshest headwinds

  • Corporate bond prices will be driven by the performance of government bonds but still offer some value

  • However, bonds should be retained in portfolios to produce fixed levels of income and portfolio insurance in a low interest rate environment


BDMS Fixed Interest Portfolio Solutions

  • Change in management style in November 2009 from direct investment to a portfolio of fixed interest Exchange Traded Funds

  • Main benefits of new construction include better liquidity and indirect access to the latest corporate bonds (a regulatory change has prevented most new corporate bonds from being accessed to private investors)

  • Performance from April 2009 to Mar 2010: +6.3% (gross of fees)

  • All Stocks Gilt Index rose by 0.8% and composite benchmark index rose by 4.8% over the same period


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