Are bonds back?

Ever since the 2008 financial crisis, the combination of Quantitative Easing and ultra-low interest rate policies, meant that yields on traditional safety assets like cash and short-dated bonds were persistently anemic.

The fact that policy rates could not go lower meant that any increase in rates for the “normalisation” of monetary policy could throw the decades-long bond bull market into reverse. For this reason, bonds were the “unexploded bomb” in traditional 60/40 portfolios going into the 2021/22 inflation crisis.

Bonds: long- or short-dated?

As Central Banks’ crank up policy rates, the casualty has been bonds (rising rates and inflation) at the same time as the equity market (falling growth). Bonds provided nowhere to hide. And unlike equities, bonds don’t bounce: if the direction of interest rates and inflation are against them, their valuation continues to get crushed, regardless of recent dire performance.

It’s too early to pile into long-dated bond exposure, whilst there is upside risk to rates and inflation, in our view. For short-dated (less rate-sensitive) bonds, yields are beginning to look attractive - at least in nominal terms.

What are the options?

We look at different short-duration bond exposures -in different currencies, for managers to match the currency of future client expenditures, or reflect any directional views.

If you don’t want currency risk, or think Sterling may stage a recovery against the Dollar, consider iShares UK Gilts 0-5yr UCITS ETF (LSE:IGLS), which offers 4.12% yield to maturity, with an effective duration of 2.27 years. For corporates, iShares £ Corp Bond 0-5yr UCITS ETF (LSE:IS15) offers 6.69% yield, with 2.53 years’ duration.

If you want to stick with a strong Dollar to diversify away from Sterling, consider iShares $ Treasury Bond 1-3yr UCITS ETF (LSE:IBTS), which offers 4.32% yield to maturity, with an effective duration of 1.86 years. For corporates, iShares $ Short Duration Corp Bond UCITS ETF (LSE:SDIG) offers 5.11% yield, with 2.27 years’ duration.

If you have any near-term Euro-denominated liabilities to match, consider iShares € Govt Bond 3-5yr UCITS ETF (LSE:IBGX), which offers 2.38% yield to maturity, with an effective duration of 3.72 years. For corporates, iShares € Corp Bond 1-5yr UCITS ETF (LSE:SE15) offers 4.01% yield, with 2.87 years’ duration.

For even shorter duration and direct relationship to Fed policy rates, consider iShares $ Floating Rate Bond UCITS ETF (LSE:FLOT), which offers 4.38% yield to maturity, with an effective duration of 0.06 years. There is also a sterling-hedged version iShares $ Floating Rate Bond UCITS ETF (GBP hedged) (LSE:FLOS).

Bonds are not yet back in vogue, but they are back on the horizon. Targeted exposures, diversified holdings and the liquid ETF format: there is no shortage of more nuanced products and providers to choose from. Credit quality, yield, duration and currency should always be the primary considerations.

(Data cited correct at time of writing).

Notices

All ETFs mentioned are London-listed ETFs and available on the IG share dealing platform.

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