Bond markets often play second fiddle to stock markets, despite them being much bigger. Bonds don’t get talked about as much in the press.
They’re not hot topics at dinner parties, and we expect conversations between friends on the next ‘hot bond’ are rare.
There’s a good reason for this. Most of the time bonds are boring.
They’re issued, they pay some income, then they mature and give investors their money back as promised. They’re not supposed to be much more exciting than that.
But here’s why bonds are getting more interesting and why we think investors should be paying attention.
What are bonds and why do they matter?
This article isn’t personal advice. If you’re not sure whether an investment is right for you, ask for financial advice. All investments and any income from them can fall as well as rise in value, so you could get back less than you invest. Income from bonds is not guaranteed and yields are variable and not a reliable indicator of future income.
Why the low interest for bonds?
In the years following the global financial crisis of 2008, ultra-low interest rates and quantitative easing pushed bond yields to record lows. Inflation wasn’t a problem, economic growth stumbled on, and bonds performed well. Bond prices rise as yields fall, so investors in bonds achieved good gains.
However, when yields reached record lows, bonds didn’t offer much income, and they were particularly susceptible to rising inflation and interest rates.
That’s because when inflation and interest rates are expected to rise, the fixed-income payments bonds offer look less attractive, so bond prices fall.
Some of the main arguments for owning bonds – to earn an income and for shelter from stock market and economic volatility – were difficult to justify when ten-year US government bonds yielded a fraction above 0.5% and global corporate bonds yielded about 1.35%.
Why are bonds now more interesting?
Fast forward a couple of years and everything has changed. Bonds are back hitting the headlines.
The pandemic set off a chain of events that caused inflation to rise globally. Central banks have increased interest rates aggressively to try to bring it under control. The theory is that higher interest rates will reduce spending and encourage saving, which will slow down the pace at which prices are rising. If you destroy demand for goods and services, their prices typically fall.
So far inflation has been more stubborn than expected. This is particularly true for the UK, which resulted in the Bank of England hiking interest rates by 0.5% last week, to 5% (versus just 0.1% as recently as December 2021). This was double the expected increase.
UK interest rates rise to 5% – what it means for stock markets, mortgages and annuities
It’s possible we’re nearing the peak of interest rate rises though. Inflation is coming down globally, even if it’s not doing so as fast as governments would like. It takes time for the impact of higher rates to feed into the economy. So, while it might not seem like rate rises are having enough impact on inflation, the medicine needs time to work.
Central banks also have a tightrope to walk. Rate rises can bring down inflation, but raise them too much and a recession is likely. If rising rates mean people must spend more on mortgage payments, if prices rise too fast compared to incomes, or if too many people save, the economy is likely to tip into recession.
The US Federal Reserve has paused interest rate hikes, and others could well start to follow.
This has left bonds higher than they were a year or two ago. The yields on a ten-year US government bond are currently 3.75%, 5.25% for global corporate bonds, and riskier high-yield bonds are yielding more than 8.5%.
So, what’s next for bonds?
Perhaps the best opportunity currently lies among global corporate bonds.
The headline yields on riskier bonds might look appealing. But these are often issued by less financially secure companies, which could struggle with their debt if economies slide into recession.
Government bonds typically offer the most shelter from a recession because investors often flock to them as a ‘safe haven’. There’s perceived to be very little chance that the US government won’t pay its debts. But the yields are lower as a result.
High-quality global corporate bonds are issued by some of the world’s biggest companies, like Apple, Netflix, AstraZeneca, and Tesco. They tend to be in good financial shape and in a reasonable position to survive recessions and economic shocks.
Lending to companies is riskier than lending to the US or UK governments, so there are higher yields on offer to compensate.
We think the extra yield offers good compensation for the extra risks over government bonds. But the additional resilience over high-yield bonds could be valuable too.
Our long-term view – we think a starting yield of more than 5% is great but this is likely to vary over time and should not be seen as a reliable indicator of future income.
Corporate bonds once again can offer a reasonable income, the potential for some resilience in a downturn, and a way to balance or diversify the risks associated with any shares you hold.
But investment is never a one-way street, and it’s possible inflation will stay high. That means further rate rises will be needed, and bond yields could move higher – of course there are no guarantees though. You could still get back less than you invest.
Want to invest in bonds?
If you’re looking to invest in bonds, funds can be a great way to do it.
Lots of bonds need very high initial values to buy them and aren’t generally available to individual investors.
A fund can give not only the expertise of the manager, but also access to a wider universe of government and corporate bonds.
You can start investing in a fund from £25 a month as a direct debit or £100 as a lump sum.
HL Global Corporate Bond fund
Richard Troue and David Smith are launching a new fund investing in corporate bonds from around the world. Invest before 11:59pm, 19 July to get the fixed launch price of £1 per unit.
DISCOVER THE HL GLOBAL CORPORATE BOND FUND
The HL Global Corporate Bond Fund is managed by Hargreaves Lansdown Fund Managers Ltd.
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