The gilt market illustrates the relative movement of short and long-dated bonds during 2013. One-year gilts saw a rise in yield (and therefore a drop in price) of just 0.01% over the 12 months. In contrast, five-year gilt yields rose by 1.03% and 10-year gilt yields by 1.23%. Only at the very long-end, 30 years, did yields prove less vulnerable, rising just 0.55%, as this part of the market was increasingly supported by pension funds.
Top of the bond tree
The top funds in each of the IMA bond sectors over the year also tended to be those with a bias to shorter-term bonds – the Threadneedle Short-Dated Corporate Bond and M&G Short-Dated Corporate Bond funds, for example – while those at the bottom have all been focused on longer-dated bonds, such as the Axa Sterling Long Corporate Bond or the Henderson Institutional long-dated Credit fund.
Figures from EPFR Global mid-way through the year showed that investors were generally prioritising short-term bonds, aiming to provide portfolios with some defence should the bond market slide as interest rates rose. It was a sharp reversal from the previous year, when investors had chased the higher yield available on long-term bonds. Equally, the majority of new launches were in the shorter maturity space, such as the three new launches from Royal London.
Shock or awe?
For the time being, the momentum still appears to be with shorter-dated bonds, despite their stronger performance in 2013. Bob Jolly, head of global macro at Schroders, says: "In Europe we will take opportunities to buy short-dated bonds whenever they sell off. Short-term rates will ultimately be anchored by low base rates and the larger shifts will happen further along the yield curve."
In other words, while the current tapering appears to be driving an orderly rise in bond yields globally, long-dated bonds are more vulnerable to a shock.
As John McNeill, fixed income manager at Kames, explains: "We continue to view the gilt market in three distinct segments: the front-end is driven by the forward guidance policy from the Bank of England which suggests bank rate will remain at the current level for a considerable period. The 7-10 year maturity area is driven by movements in global bond markets and this direction has been higher, driven by better economic news and expectations of less easy policy from the US Federal Reserve. The long end of the UK gilt market is enjoying strong support from pension funds."
There is still a danger that those investors who have bought into longer-dated gilts for higher yields exit quickly if those yields become available elsewhere with less risk (if Fed tapering prompts a rise in shorter-dated yields, for example).
Russ Koesterich, Blackrock’s global chief investment strategist, agrees that the long end looks vulnerable: "There are few bargains in fixed income markets, with rates likely to rise and inflation still low, we would avoid both long-dated treasuries and treasury inflation-protected securities."
Still a risk
Evolve Financial Planning also points out another advantage to shorter-dated bonds – correlation benefits: "Short-dated bonds in portfolios have added real correlation benefits and true diversification to portfolios during a very volatile period. On a total return basis, whilst the FTSE All Share lost 30.6% in 2008, the Dimensional Global Short Dated Bond fund rose 6.2%. The long-term diversification benefits of bonds are significant, and during periods of risk aversion, high quality, short-dated bonds can serve investors particularly well."
The risk to the general preference for shorter-dated maturities is if the economic recovery does not pan out as expected, quantitative easing is resumed, and interest rate rises become increasingly unlikely. Then the expectations in longer-maturity bonds would start to look wrong. However, for the time being at least, most believe this is an unlikely scenario.