The chart shows that apart from a sharp short-term fall of at the height of the markets panic in March Government Bonds, conventional and linkers, have been the safest of havens this year, posting strong returns. Since April though it has been investment grade and High Yield corporate bonds which have produced the best returns as spreads (the yield pick-up over Gilts, in effect the risk premium) have tightened sharply as risk assets recovered their nerve.
As we have noted, policy intervention was the biggest single driver of bond yields last year. The ability of Central Banks to buy unlimited quantities of government and corporate debt means yields will remain anchored near zero for the next few years so bond investors will receive meagre income with little prospect of capital gain. Indeed, if yields begin to push back up then bond prices will begin to fall. UK Gits are negative up to 5 years with the 10-year paying a paltry 0.20% and it’s the same elsewhere with rates negative across much of Europe and in Japan. US 10-years are paying 0.9% and Government bonds are fast becoming a liquidity play only, with their ability to add diversification to multi-asset portfolios severely diminished.
In a world where income is in very short supply credit markets still have attraction for investors, especially in lower risk/reward profiles. The risk of capital loss in credit is not so much the underlying yields rising, as we expect them to remain anchored this year, but in spreads widening if markets become ‘risk off’ again. Consequently we prefer higher quality investment grade with far less risk of default than in the seductive but riskier world of High Yield. There is however only a limited prospect of further tightening in spreads from current levels after the strong rally in credit markets from their lows in March.