Back into bonds?

Bonds have been an unloved asset class of late as investors’ mad scramble for yield has pushed the cost to unpalatable highs and they sought safety in cash, but does an impeding equity market correction mean that is set to change?

A lot has been made recently of both wealth managers and fund managers increasing cash holdings in their portfolios to act as a cushion against a potential downturn in equity markets.

A recent Legg Mason study found a third of wealth managers, who together manage in excess of £100bn, revealed they are holding cash across their clients’ portfolios to protect against an imminent correction.

Others, however, have been less inclined to bump up the cash. Rathbone Global Opportunities lead manager James Thomson said he has “never been so invested” after reducing the portfolio’s cash weighting to 0.64% from 1.10% in October.

This view is reinforced by the latest Bank of America Merrill Lynch (BoA ML) fund manager survey which found the average cash balance held by global managers fell to 4.4% in November from 4.7% in October – the lowest level since October 2013 and below the 10-year average of 4.5%.

"You can suddenly go really defensive but then the danger is that spreads stay the way they are. That is why we are still overweight high yield."

Not all about cash

With cash clearly dividing opinion, bonds, particularly strategic bonds, appear to be re-staking their claim as defensive asset class du jour in certain portfolios as fears of an equity correction loom.

According to the latest Investment Association sector flows data, strategic bonds are continuing to dominate the pickings. During September, the sector accumulated net inflows of £985m – the third month in a row the sector has topped the rankings.

This acceleration in flows is perhaps unusual given it occurred at a time when investors were expecting a rate rise from the Bank of England. However, the flexible nature of strategic bond funds means they should protect against volatility, hence their appeal.

For Torcail Stewart, manager of the Baillie Gifford Corporate Bond fund, the economy’s lights are flashing green as deflationary pressures continue to dampen rising inflation. If there is a correction, Stewart believes it will be behavioural.

He explains: “With high-yield markets having done as well as they have of late, psychologically some managers still have the global financial crisis in mind so think there will be a correction. But if you look at the global economies, the US, Europe and China, everything is flashing green, the economies are all motoring quite strong and the other peculiar aspect is inflation is trending down.”

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