PA ANALYSIS: Have bond markets entered Twilight Zone territory?

There is a change happening in the City. One that would not be out of place in an episode of the Twilight Zone.

PA ANALYSIS: Have bond markets entered Twilight Zone territory?


In boardrooms and cafes, seminars and sales pitches, bond managers are talking about capital gains. Meanwhile, equity managers are often almost exclusively talking about the income potential of the companies they hold.

On the surface it may not seem that big a change. After all, equity income has been a thriving sector in the UK for decades. Likewise, bonds have been in bull territory for more than 30 years. But, at a portfolio theory level, it speaks to just how topsy-turvy markets have become. To put it another way, down is up and up is down in a world distorted by quantitative easing; a world where over 35% of global government bonds have negative yields.

And, if BlackRock and JP Morgan are to believed, it is a distortion that it likely here to stay.

Speaking at JP Morgan’s European Media tour on Wednesday, Nick Gartside international CIO, global fixed income within JP Morgan’s currency and commodities group said bond investors need to be doing something very different to what they have done for the past 30 years if they are to thrive in this new world: they need to be active, nimble and focused on generating capital gains. And, they need to look beyond the traditional fixed income sectors, to focus on high yield and emerging markets, in particular.

The reasons for this, he explained are largely because of the flattening of the yield cushion that has traditionally existed as durations has risen and yields have declined. A corollary to that, is the need to focus on income in a world where the income potential inherent within most issues has fallen dramatically – evident in the graph below, which breaks down the sources of fixed income returns in recent years.


This graph, he said is another of the early signs that this difference in how bond funds are being managed.

“Historically, you had a benchmark and took a position relative to it. The risk then really was the benchmark, if the benchmark didn’t do well you were in trouble. Now the benchmark is dominated by duration risk which means investors are having to move away from it,” he said.