investors steer clear of prolonged gilt trip

In his latest blog, M&Gs Richard Woolnough reflects on Mervyn Kings recent proclamations that we may well be less than half-way though this fiscal crisis. The question is: do investors have the patience to sit tight in low-yielding assets for another five years?

investors steer clear of prolonged gilt trip

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The Bank of England base rate has been set at 0.5% since March 2009, while over £325bn has now been pumped into the financial system through quantitative easing.

“If we are not yet half-way through this crisis, then this implies that rates will stay at these levels for at least another three years to 2015, and a further round of £375bn of QE is potentially on the agenda,” says Woolnough.

“If this interpretation of the outlook turns out to be correct then these very low levels of short and long-term gilt yields begin to look more logical to gilt investors.”

UK professional investors often appear to have a love/hate relationship with gilts. While few predict any long-term gains from the asset class, most still hold on.

Hell in a handcart

As Justin Oliver, investment director at Collins Stewart, remarks: “We have US and UK government bonds not necessarily because we can see value in that market but because we have to recognise that, when the world is going to hell in a handcart, people are still flocking to government bonds which act as a counterbalance to risk assets, like it or not.

“If we were looking to fund any increase to equity exposure then the government bonds would be where we would look to take out. But for this moment in time, in an uncertain world, we think it is appropriate to have exposure there albeit that we can’t get excited by the yields on offer.”

Still, as has been pointed out before, gilt funds have actually outperformed other fixed income asset classes. Over the past 12 months, the average fund in the IMA UK Gilt sector delivered a 16% total return, while the UK Index Linked sector delivered 13%, according to FE Analytics.

This compares to a 7% return from the Sterling Corporate Bond sector, not far ahead of the lauded Strategic Bond sector – where fund managers have flexibility to invest across the fixed income spectrum – at just 6%.

A word of caution

Views on gilts as an asset class are often tied in with investors’ assessment on the Government’s perceived successes or shortcomings. Often these are negative judgements, but should investors take a more favourable view on our sovereign debt?

A word of caution comes from FE’s recent research which apparently shows that gilts have becoming increasingly risky this year relative to UK equities.

According to its Risk Score criteria, which measures volatility compared to the FTSE 100, the volatility of the IMA UK Index-Linked Gilt sector increased by 10.4% while that of the IMA UK Gilt sector rose by 8.8% this year (to 11 May). From a longer term perspective, it says gilts have been much more volatile since the financial crisis compared with pre-2008 levels.

Whatever the risks or returns, gilts are unlikely to lose their safe haven status anytime soon. For investors though it’s clear that, if the environment permits, they would much rather take a chance in risk assets.

 

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