Within the UK, however, while the growth outlook has deteriorated somewhat since the EU referendum, Spreadbury says corporate bond spreads remain attractive.
“To put it into perspective, the 10-year gilt is giving you about 77 basis points, whereas you can get triple that by investing in the likes of Seven Trent and Imperial Tobacco, which are pretty high-quality bonds at the 10-year point.”
The fund does, however, remain underweight financials, primarily because while these companies’ balance sheets have been repaired, they remain highly levered and their correlation to stocks and volatility remains elevated.
They do still have around 17% in financials but that is focused on areas such as insurance and covered bonds.
Liquid solutions
At a broader level, cash is also becoming increasingly important. “Given all the money that has gone into corporate bond funds in recent years, that there could be some liquidity pressure,” Spreadbury says.
In order to manage that liquidity risk, the Moneybuilder fund has about 20% in liquid-type instruments – government bonds, supra-nationals or quasi-governments and cash – which gives it a good buffer.
He adds: “If it became a systemic problem, I am convinced the Bank of England would step in and buy corporate bonds.”
Within the firm’s strategic bond fund, around a third of the portfolio is in government bonds of various types across different sovereigns. All of this means the funds will not be forced sellers in times of stress. This also provides flexibility to take advantage of opportunities as they arise.
Such flexibility is important because of the tension that exists for investors between getting the yield they have come to expect and the desire to stick to those instruments that have provided the low volatility and uncorrelated type of returns that bonds have provided historically.
While Spreadbury believes that one can have both, he says it is important to ensure investors know what they are getting.
“Many investors have taken the route of going down the credit curve to get the yield, which is fine, but the key thing is explaining that to them. We have been consistent in maintaining the focus on safety,” he says.
“The bull market will turn eventually but it’s difficult to forecast how or when.”
Structured returns
The reason for this uncertainty is that there are a number of significant structural issues at play within the markets.
Primary among these is the debt burden under which the global economy is currently struggling.
Spreadbury explains: “The problem with high debt is it is associated with slow growth, to the extent that the debt is not used to generate real wealth. Then, to some degree, you are borrowing from the future, which means you will end up with slower growth. It is a problem that has been with us for a while, and it has been a significant driver of the slow growth in recent years.”
If one adds this to the demographic challenges facing the developed world and the fact that nominal growth is what drives bond yields, the outlook does not look great.
“We are in a world where growth and inflation will be low and the way the authorities have dealt with that has led us to a set of policies we have never seen before.
“In Japan, the volatility of equities has been substantial and, even at a low-yield level, as an equity diversifier bonds are pretty important. There is a limit to how attractive bonds are at these levels but I still feel there is a case for them.”
Vaid agrees: “The Japan template is a good one for what we can expect. Absolute returns are going to be lower from all asset classes and volatility substantially higher.”
But while Vaid believes bond yields are going to look extremely low from a historical perspective, he does not believe they are in a bubble.
“There are fundamental reasons why the yields are where they are. As the market addresses some of these structural issues, with a risk-adjusted, volatility-adjusted point of view within a diversified portfolio, the characteristics that fixed income provides is something investors will need.”
Spreadbury adds: “There are reasonable yield opportunities. There are corresponding risks but on a diversified basis there is some value there. I think the message is, investors have to decide what they want the mix of safety, volatility and yield to be.”
