The recent period has upended much of the received wisdom about bond investing, and what role it can play for the small investor.
The extraordinary conditions in play since the financial crisis - with central banks keeping interest rates low and embarking on vast bond-buying programmes - has distorted normal bond market conditions.
It’s the job of bond managers like Ariel Bezalel, who runs the Jupiter Strategic Bond Fund, to makes sense of it all - and the job isn’t getting any easier.
“The risks just seem to be growing by the day lately”, he says. “It’s not just the economic risks we’re focusing on. There’s concerns geopolitically, there’s concerns domestically - but in addition to that we also have concerns around the interest rates picture, the inflation picture.”
Making the right calls on interest rates and inflation is perhaps the central task of bond managers, as these are the factors that, in large part, determine the price that the market is willing to pay for bonds.
Higher interest rates increase the return on risk-free cash, meaning bond prices have to fall to make the income they pay an adequate reward for the extra risk being taken. Higher inflation increases the chance of central banks raising rates to curb price rises, but it also erodes more quickly the cash income that a bond pays, reducing its appeal.
Bond prices soared after the crisis as rates were slashed but this situation has begun to change, with central banks now on a tightening path. That’s seen as a risk to bonds. Bezalel recognises the risk but is less sure that a reversal of bond price rises is inevitable.
He says: “There are many out there with the belief that it’s only a matter time before we see a pick-up in inflation, and that central banks are behind the curve and are going to tighten more aggressively. That could potentially lead to a tick up in bond yields.
“Our belief is that the interest rate outlook is still quite benign. A lot of the things we’ve been concerned about: too much debt; continuing disruption from internet companies which is leading to downward pressure on prices; and finally demographics - demographics in the emerging part of world are not good - we’re seeing ageing populations - are typically disinflationary.”
He adds that the distortion of economies and markets since the crisis has been so extreme that a smooth return to normality is unlikely.
“We are seeing the biggest unwinding of the biggest monetary experiment of our lifetime and no one really knows what the impact of that is going to be. My concern is that, as the pace of tightening picks up, the volatility could really start to pick up. In a world shrouded in so much debt, every 25bp increase in rates is so much more magnified than in the past.”
Dealing with this volatility is what the Jupiter fund is designed to do. Like other bond funds, it invests in the debt issued by governments and companies around the world, but the ‘strategic’ part gives it a wider universe of debt to turn to.
While traditional bond funds stick to one part of the fixed income universe – government debt, for example, or high-yielding debt - Bezalel is able to move wherever he and his team find opportunities, be they in the emerging economies of the world or higher risk areas of corporate debt.
He can also bet against price rises if he sees fit, through the use of financial instruments called “derivatives”.
That extra flexibility to jump around the markets is likely to prove valuable. The Jupiter Strategic Bond Fund is on our Select 50 list of preferred funds.
The value of investments and the income from them can go down as well as up, so you may get back less than you invest. Investors should note that the views expressed may no longer be current and may have already been acted upon. This fund invests in overseas markets so the value of investments can be affected by changes in currency exchange rates. The fund also invests in emerging markets which can be more volatile than other more developed markets. This fund uses financial derivative instruments for investment purposes, which may expose the fund to a higher degree of risk and can cause investments to experience larger than average price fluctuations. There is a risk that the issuers of bonds may not be able to repay the money they have borrowed or make interest payments. When interest rates rise, bonds may fall in value. Rising interest rates may cause the value of your investment to fall. Due to the greater possibility of default an investment in a corporate bond is generally less secure than an investment in government bonds. Sub-investment grade bonds are considered riskier bonds. They have an increased risk of default which could affect both income and the capital value of the Fund investing in them. This information is not a personal recommendation for any particular investment. If you are unsure about the suitability of an investment you should speak to an authorised financial adviser. This information is not investment advice and must not be used as the basis of any investment decision, nor should it be treated as a recommendation for any investment.