Bond Watch: is this bond fund type too good to be true?

Sam Benstead breaks down the latest news affecting bond investors.

Welcome to interactive investor’s ‘Bond Watch’ series, covering the latest market and economic news – as well as analysis – that is relevant to bond investors.

Our goal is to make the notoriously complicated world of bond investing simpler, by analysing the week’s most important news and distilling it into a short, useful and accessible article for DIY investors.

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Here’s what you need to know this week.

High yields on short bonds – a win-win?

Bonds are issued by companies and governments with different maturity dates. Generally speaking, the bonds that have the longest time before they mature offer higher yields to compensate investors for locking up their cash for longer periods.

But this is not always the case. An inverted yield curve, like we have at the moment, means investors get a higher yield from owning shorter dated bonds – those set to mature in the next couple of years.

This is an opportunity for investors, according to fund manager AllianceBernstein, as investors can get a higher return for less risk.

It said: “Now, with yield curves inverted across North America, Europe and parts of Asia, investors no longer need to increase interest-rate risk (duration) to earn extra income.

“Shorter bonds make for lower risk. Short-dated high yield bonds are intrinsically less risky than longer-dated counterparts, as their shorter maturities leave them less exposed to both default and interest rate risk.

“Further, as these bonds currently trade below par, their prices will likely rise as they approach maturity, generating capital gains.”

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It adds that concentrating on the higher-quality segment of short-dated high yield means investors can create more defensive portfolios for a relatively small reduction in yield.

“In an uncertain world, we think shorter-dated, higher rated, high-yield strategies could be particularly well-suited to delivering attractive risk-adjusted returns,” the fund group said.

There’s no dedicated short-dated bond fund sector. However, to find such funds they will have ‘short duration’, ‘short dated’ or ‘short term’ in their fund name.

Can bonds protect your portfolio in a recession?

Tracy Chen, portfolio manager at fund manager Brandywine Global, joined a number of her peers in backing bonds to resume their role as defensive ballast in portfolios.  

“We believed something would break in the economy even before this banking crisis happened. And now bonds are actually providing a safe haven and protection for investors’ portfolios.

“Our timeline for recession is pulled forward because of this banking stress. The Federal Reserve will be struggling, fighting inflation while also maintaining financial stability. But I think this should be a good year for the bond market.”

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The safest bonds, such as those issued by the US or UK governments, or “investment grade” corporate bonds from blue-chip companies, tend to rise when investors are worried.

However, they are still sensitive to interest rate risk – particularly bonds with longer maturity dates. When rates rise, bond prices fall as investors can get better yields by investing in newly issued bonds.

Grocery prices keep rising

There was more evidence that the cost-of-living crisis will not abate soon in the UK this week. Kantar, a market research firm, reported that grocery prices rose 17.5% year-over-year in March, as pasta, bread and eggs jumped substantially in price. This was the greatest monthly price increase since records began in 2008, it said, and followed annual price rises of 17.1% in February.

Higher food prices may push the Bank of England to raise interest rates even higher in a bid to cool the economy and rein in price rises.

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In its notes last week after it raised interest rates 0.25%, the central bank said: “CPI inflation increased unexpectedly in the latest release, but it remains likely to fall sharply over the rest of the year.

“Services inflation has been broadly in line with expectations. The labour market has remained tight, and the near-term paths of gross domestic product and employment are likely to be somewhat stronger than expected previously. Although nominal wage growth has been weaker than expected, cost and price pressures have remained elevated.”