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Fixed income ‘exciting for the first time in years’

Paloma Kubiak
Written By:
Paloma Kubiak
Posted:
Updated:
11/10/2022

For the first time in over a decade, the fixed income sector is “really interesting”, the head of investments at Atomos has said.

Fixed income tends to be seen as less risky and less exciting than equities as it helps preserve capital and provide investors with a reliable income.

But, in recent times, rising inflation and interest rates have created a “perfect storm” for the sector, with inflows slumping to £72m in September 2022, according to global fund network Calastone.

When interest rates rise, gilts become comparatively unattractive, so their price falls. The income you get on a gilt is fixed, so when the price falls, the yield rises. Bond yields have risen across several countries this year as high inflation hits global growth.

Bank moves curbs yields

But Chancellor Kwasi Kwarteng’s £45bn in unfunded tax cuts sparked a surge in gilt bond yields. The 30-year yield skyrocketed to nearly 5% before the Bank of England stepped in with an emergency bond-buying programme to bring stability to the market.

Haig Bathgate, head of investments at Atomos – newly rebranded from Sanlam Wealth – says the move by the Bank was “quite smart” and it “reacted fast” as it continues to deal with soaring inflation.

He says: “This was pretty unprecedented. The Bank of England want to move short-term interest rates up and have direct control, but not just for short-term interest rates but for how the economy performs. It wants a fully functioning government bond market to work effectively, and this is down to asset liability matching for pension funds.

“That’s why it stepped in. Pension funds want the average maturity of fixed income in bond portfolios to match the average age of retirees. If the market moves too quickly, it pushes the hedge out of kilter so yields rise and they have to return more earlier on.”

Bathgate explains that on a 25-year bond trading on 0.5% yield which then moves to 5% every year, it “massively brings forward the bond return to earlier years, while the average retirement in the fund remains the same”, which is why pension funds were forced to sell bonds, and the Bank forced to step in with its bond-buying programme.

“The Bank of England responded to promote a stable market, it’s not just about short-term interest rates, but using its buying power to control interest rates at or on maturity which is very sensible”, he says.

However, he says: “I don’t think the Bank will do whatever it takes to control the gilt market, but I think that’s the peak [25-year] which is really important for pensions.”

Build fixed income positions now

Bathgate, who has been through five bear markets since 2007, adds that for the first time in 12 years, fixed income is “now really interesting”, adding it is “sensible” for investors to start building their fixed income positions now because of the market discount expectation.

“Probably for the last 10 years, there’s been no income. But interest rates have gone up and investors should readjust their portfolios to lock in some of those yield figures.”

On 27 September, when the gilt market was at its worst, the 10-year gilt stood at 4.5% but since the BoE intervention, it fell to 3.9% “which is still pretty attractive”.

The aim’s bond

Meanwhile, he adds that he doesn’t think interest rates will remain at this level for a sustained period of time which adds to the attractiveness of fixed income.

“We’re too far in the mindset that rates will stay high, but I don’t believe that and I don’t think the facts point to that case.

“If interest rates fall, this is very attractive for bonds”, he says.

He adds that “all sectors of fixed income are exciting for the first time in 12 years”, but cautions against Asian debt as it would be “premature” to get into the Chinese market, but says “Western markets look pretty robust in the medium term view”.