Yields on government bonds issued by the UK, the US and German have hit multi-year lows as investors’ flight to safety and quantitative easing led to significant demand for the assets.
Although the asset manager concedes that government bonds have been a “success story” in recent years, its current view is that they are likely to deliver low to negative real returns over the medium term.
Alec Letchfield, chief investment officer for HSBC Global Asset Management’s UK private client business, said: “When uncertainty is high, core government bonds warrant a place in a balanced portfolio. But it is the returns angle that concerns us.”
Letchfield added that investors should identify assets that display similar characteristics to government bonds, such as lower volatility assets, capital preservation at points of market stress and the potential to generate an above average income.
“We would highlight the real estate sector, infrastructure, emerging market bonds and higher yielding equities of companies with strong balance sheets,” he continued.
“Whilst by no means perfect on all of these measures, especially as the correlation of these assets with risk assets such as equities can increase at points of market stress, they do however provide useful alternatives.”
Offering the benefits of these holdings, Letchfield noted that property and infrastructure aim to generate yields through real, tangible assets and have diversifying characteristics in a portfolio.
Emerging market debt, meanwhile, has performed well on a historical basis and is likely to remain attractive as emerging market currencies appreciate over time. He also pointed out that equity valuations are low compared with history.
“Given the current climate of additional short-term volatility, having a lower level in bonds may result in potentially longer term returns, provided investors are able to tolerate this additional volatility in the short-term and are willing to invest for the longer term,” Letchfield concluded.
