In recent years, bonds have defied many of their long-held investment beliefs — sticky inflation led to a delay in interest rate cuts throughout 2024, and investors contended with the bond and equity market moving in tandem.
Now, another turn in truths may be occurring for the asset class, as the risk factors of corporate and government bonds begin to shift. According to Shaniel Ramjee (pictured), co-head of multi asset at Pictet Asset Management, bonds issued by corporates are currently “paradoxically safer”.
“A lot of corporates have managed their balance sheets very well. They’re not as leveraged as they have been in the past, and therefore the spreads that they trade out over and above governments are low, but they might stay low for longer periods of time because of the nature of a much more diversified opportunity set,” Ramjee said.
“These corporates aren’t as indebted as the governments, and by and large, we see less and less corporate bonds being issued versus government bonds being issued every week. The supply and demand of these two asset classes is different. So I think paradoxically, we’re in a period where government bonds are riskier than usual, and actually corporate bonds can be less risky than usual. And I think that’s an interesting difference today than we might have seen in years gone by.”
While the issuance of some corporate bonds has caused a bidding war among investors, government bonds from typically desired countries such as the US and UK are all too available for investors as they attempt to stimulate their economies.
Other countries with typically stable markets, like France, have been rocked by political uncertainty. French 10-year government bond yields currently sit above 3.4%, almost a percentage point above the 2.6% levels of last January. French yields now sit in line with the government bond yields in Greece.
See also: What does the gilt yield spike mean for UK bond prospects?
“Ultimately, these governments have borrowed a lot of money. They’re highly leveraged, and unfortunately, like we see in the UK, the propensity for these governments to want to come and borrow is very high. So the risk is that the credit worthiness of those countries are deteriorating, and no one wants to really think about reducing spending,” Ramjee said.
As of October 2024, the estimated UK government bond issuance for the 2024/25 fiscal year was £294bn following an expansion by Rachel Reeves during the Autumn Budget.
When markets opened on the day of the budget, the yield of a UK 10-year gilt sat at 4.27. As of market close on 6 January, the yield is 4.61. Year on year, yield has increased by 23%. In the last week, 30-year gilt yields hit their highest level in near three decades.
To Ramjee, this could be the beginning of a larger problem if the economy is not able to grow under the new fiscal policies.
“Particularly within the UK, we’re at a really high tax burden. But on top of that, what’s happening is that if you don’t grow the economy, the risk is that the government has to come back for more taxes in the coming years. And I think that’s the other element that markets are worried about, especially in UK gilts, is that the tax rises have not finished,” Ramjee said.
“That’s why it’s so important to have growth policies along with any other tax rises, because if you don’t have them, then the market will get more concerned that you’re not doing anything to actually to grow the economy. That’s what’s been weighing on the gilt markets to date.”
See also: Will bond yields stay higher for longer?
As the asset class shifts, Ramjee said its use in portfolio’s becomes less clear: government bonds in particular were traditionally seen not just as a diversifier against equities, but a way to manage levels of risk. Now, Ramjee said it can not be relied on as heavily for either of those reasons.
“Government bonds provided a good stabilizer in a portfolio. They provided income, but they also provided a diversifying effect. When equities went down, bonds went up, and that helped the overall balance of a portfolio.
“What we see now as those debt levels have risen, and as the risk in those government bonds has risen is that the correlations are no longer as good for multi-asset portfolios, so you can’t rely on them as much as you could before to give you that diversification. And I think that is worrying from a multi asset standpoint, that you have to rely on different types of assets to diversify you.”