The chart shows that 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.
Policy intervention has been the biggest single driver of bond yields. The ability of Central Banks to buy unlimited quantities of government and corporate debt means yields will remain anchored at super low levels for years to come so we expect flatline returns and low volatility. The problem for bond investors is that yields are so incredibly low that they produce virtually no income or prospect of capital gain. UK Gilts are negative up to 8 years with the 10-year paying a paltry 0.20% and it’s the same elsewhere. US 10 Year Treasuries are paying 0.70% and rates are negative across much of Europe and in Japan. Government bonds are fast becoming a liquidity play only, with their ability to add diversification to multi-asset portfolios severely diminished.
In this income starved world we see credit markets as an attractive ‘halfway house’ for investors, especially in lower risk/reward profiles as there is a far greater degree of comfort in solvency and coupon payments from bonds than in earnings expectations and slashed dividend payments from equity where the risk of capital loss is far, far greater. It certainly helps that Central Banks are significant buyers of corporate credit as part of their QE programmes, protecting companies from default and thus underpinning the asset class. The risk of capital loss in credit is not so much the underlying yield rising but spreads widening if investors 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, or junk, as it used to be called back in the day.