The biggest concern for bond markets over the last quarter has been dealing with a widespread banking crisis. It started in the US with Silicon Valley Bank, then jumped across the pond to put pay to Credit Suisse, before heading back to the US and finishing off First Republic.
So what has this all meant for bonds?
This article isn’t personal advice. If you’re not sure whether an investment is right for you, please ask for financial advice. All investments can fall as well as rise in value, so you could get back less than you invest. Past performance isn’t a guide to the future.
A banking crisis
We witnessed the biggest banking collapse in the US since 2008, when Silicon Valley Bank was consigned to the history books on 10 March. This caused some ripple effects across the sector in the US and Europe, which resulted in the demise of some other banks too.
What caused the US banking crisis and what could come next?
Credit Suisse got caught up in the ripples, and following intervention by the Swiss National Bank (SNB), was bought by the Union Bank of Switzerland (UBS). As part of the negotiations for the purchase of Credit Suisse by UBS, it was agreed that Credit Suisse would default on some of the bonds they had issued.
A default means that the issuer will not meet the payment terms of the bond. Every default is slightly different so the impact on the value of the bonds is case specific. In this particular instance, the outcome was that Credit Suisse stopped all payments relating to these bonds, meaning they effectively became worthless overnight.
This caught many investors by surprise. The specific bonds that were wiped out were designed to be the first to go if the bank ever came under significant financial pressure. Financial pressure in this context was defined as the bank’s reserves falling to a specified level. At this point they would be allowed to default on these bonds in the hope they would be able to continue to pay the rest of their debts.
A key problem was, the bank had notably higher reserves in place at the end of 2022, the latest available data point. It’s unlikely these reserves had fallen significantly between the end of 2022 and the time the bonds were wiped out by the SNB as part of the negotiated deal for UBS to buy Credit Suisse. Meaning bond investors were caught off guard, and lost nearly all of the money they had invested in these bonds.
Ultimately, banks are unique businesses who are reliant on consumer confidence in order to continue operating.
A timely reminder that interest rate rising cycles can cause things to break. Often, it’s things that no one expects.
What’s happening in the bond market?
The three months to the end of April 2023 generally saw bond yields move around but end up at similar levels to those at the end of January.
Looking at the yields on 10-year government bonds from the UK, US and Germany (a proxy for Europe), on 30 April 2023 these sat at 3.8%, 3.4% and 2.3% respectively. At the end of 31 January 2023 these were 3.3%, 3.5% and 2.3%.
While those numbers don’t look particularly different, especially for the US and Germany, it hides what happened in between. Peak values of these yields were 3.9%, 4.1% and 2.8% respectively during the three months to the end of January, highlighting a volatile period.
The 10-year UK government bond yield is the only one to end the period at a notably different level to where it started. UK government bonds (gilts) are suffering from more stubborn inflation in the UK compared to other regions, alongside a higher supply of new gilts in 2023. Both of which are negative for bond prices (bond yields move in the opposite direction to bond prices).
Going forward it’s difficult to know where yields go from here. However, following the recent round of 0.25% rate increases in the US, Europe and UK, it’s reasonable to expect we’re closer to the end of the rate rising cycle than we were three months ago. The US in particular seems to be approaching peak rates, if they’re not already there.
Lots of investors are already moving on to the next question – ‘when will interest rates start to be cut?’. This seems to be true despite concerns around how sticky core inflation is in the US.
I’m therefore going to end this update as I did my last – it’s difficult to say what this will mean for bond values, especially over the short term. But what’s likely is more ups and downs for bond prices until things become a bit clearer.
UK inflation falls, but what’s next for interest rates and the economy?
How have our fixed income Wealth Shortlist funds performed?
Our Wealth Shortlist bond picks have delivered mixed performance over the past year. Some have outperformed their peer group, while others have underperformed.
We wouldn’t expect them all to perform in the same way though. If all your funds in a sector are performing well at the same time, they're probably investing in similar areas.
Investing in funds isn't right for everyone. Investors should only invest if the fund's objectives are aligned with their own, and there's a specific need for the type of investment being made. Investors should understand the specific risks of a fund before they invest, and make sure any new investment forms part of a diversified portfolio.
For more details on each fund and its risks including charges, see the links to their factsheets and key investor information below.
The best performing Wealth Shortlist fixed income fund over the last year was Invesco Tactical Bond with a return of -0.43%*. Past performance isn’t a guide to the future.
Stuart Edwards and Julien Eberhardt invest across the spectrum from higher-risk high-yield bonds through to government bonds and cash. They'll also adjust the fund's sensitivity to changes in interest rates.
The pair are given a high level of geographical flexibility and are able to use derivatives which can increase risk. What's different about this fund is the degree to which the managers shift their investment allocations – they can invest a lot more in one particular theme.
The fund’s low duration positioning throughout much of 2022 helped it lose less value than peers as interest rates rose. Duration is a measure of how sensitive a fund is to interest rate movements. The lower the duration the less sensitive fund performance is to interest rate changes. As interest rates rise, bond values typically fall.
MORE ABOUT INVESCO TACTICAL BOND, INCLUDING CHARGES
INVESCO TACTICAL BOND KEY INVESTOR INFORMATION
The worst-performing Wealth Shortlist fixed income fund over the last 12 months was the Legal & General All Stocks Gilt Index fund, returning -15.45% over the period**. As always, past performance isn’t a guide to the future.
The fund offers a simple way to invest in UK government bonds across all maturities. It can help diversify a portfolio focused on shares or other types of investment. Inflation and rate rises have resulted in the fund losing money over the period. As this is a passive fund that aims to track the market, overall performance is largely out of the manager’s hands.
MORE ABOUT LEGAL & GENERAL ALL STOCKS GILT INDEX INCLUDING CHARGES
LEGAL & GENERAL ALL STOCKS GILT INDEX KEY INVESTOR INFORMATION
Annual percentage growth
| Apr 18 -Apr 19 | Apr 19 – Apr 20 | Apr 20 – Apr 21 | Apr 21 – Apr 22 | Apr 22 – Apr 23 | |
|---|---|---|---|---|---|
| Invesco Tactical Bond | 0.15% | 4.12% | 12.43% | -2.24% | -0.43% |
| IA £ Strategic Bond | 2.66% | 1.19% | 9.46% | -5.11% | -3.83% |
Past performance isn’t a guide to the future. Source: *Lipper IM, to 30/04/2023.
Annual percentage growth
| Apr 18 -Apr 19 | Apr 19 – Apr 20 | Apr 20 – Apr 21 | Apr 21 – Apr 22 | Apr 22 – Apr 23 | |
|---|---|---|---|---|---|
| Legal & General All Stocks Gilt index | 3.14% | 14.33% | -7.48% | -7.71% | -15.45% |
| IA UK Gilt | 3.08% | 15.38% | -7.99% | -7.71% | -16.12% |
Past performance isn’t a guide to the future. Source: **Lipper IM, to 30/04/2023.
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Our fund research is for investors who understand the risks of investing and that investing in funds isn't right for everyone. Investors should only invest if the fund's objectives are aligned with their own, and there's a specific need for the type of investment being made. Investors should understand the specific risks of a fund before they invest, and make sure any new investment forms part of a diversified portfolio.