Elston, chief investment officer at Seneca IM, said he agrees with Janus Henderson bond veteran Bill Gross that the end of the 25-year bond bull market has arrived, but is concerned many investors still believe bonds are a safe asset class.
He said this mindset must change because of the potential negative effect strong economic growth, tighter monetary policy and rising inflation in the UK and US will have on bonds.
The former head of Asia Pacific strategy and asset allocation at Aberdeen Asset Management said this combination creates a “very negative” environment for bonds which now have low or negative real yields compared to the last 30 years when returns were in the 5-7% range.
Elston predicted UK inflation could climb as high as 4% over the next 10-20 years, particularly with unemployment so low.
Seneca is investing in short duration high-yield bonds to avoid duration risk, as well as emerging market debt in local currency. The firm has no exposure to developed government bonds because of the low, sometimes negative, real yields.
“There is nothing that exists today that will give you what bonds did 20 years ago,” said Elston. “Absolutely nothing. You have to find the next best thing and that is where these bonds are useful.
“The only way to get good returns from bonds is if you have deflation for a long period of time and central banks know how to control inflation.
“Do you really want to bet against central banks? I don’t think you should.”
Seneca is moving underweight equities in its three multi-asset funds by one percentage point every two months on the belief that the bull market will come to an end in 2019 and recession will hit the global economy in 2020.
The LF Seneca Diversified Income fund, the LF Seneca Diversified Growth fund and the Seneca Global Income & Growth Trust hold 38%, 56% and 58% in equities respectively, versus the strategic allocations of 40%, 60% and 60%.
As well as short duration high-yield bonds, proceeds from the equity reduction are being put into specialist assets that include Reits, infrastructure, specialist financial assets such as asset leasing and direct lending, and private equity.
Elston said private equity acts as a bond proxy because it offers a high yield and a stable income stream which is often linked to inflation.
He also believes cash will become more attractive over the next two years as central banks increase rates.
