Bond Watch: why Personal Assets prefers short bonds

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.               

• Invest with ii: How Bonds & Gilts work | What is a Managed ISA? | Buy Bonds

How inflation views affect the bonds fund managers buy

Bonds come with different risk and return profiles. One key thing to be aware of is a bond’s “duration”, which is its sensitivity to interest rates. Bonds with longer maturity dates (when the principal amount is repaid to the investor) and lower coupons (rate of interest paid by the issuer of the bond) have a greater duration, meaning they will rise in value more if interest rates fall, and fall more when rates rise.

Inflation is the key determinant of interest rates, so fund managers who think it will fall faster than the market expects may buy longer-dated bonds, while those that expect a stickier inflation environment may do the opposite.

Personal Assets Trust manager Sebastian Lyon prefers low duration bonds because he thinks that inflation will be higher for longer than other investors expect.

He runs a “wealth preservation” investment trust, which aims to protect investors’ capital as its top priority, before then growing it.

• Benstead on Bonds: these lower-risk funds are best income opportunity
• Sign up to our free newsletter for investment ideas, latest news and award-winning analysis

Lyon says that at the beginning of 2024, the consensus forecast was for no less than six interest rate cuts over the coming year from the US Federal Reserve and the Bank of England. Yet so far this year there have been no cuts from these two central banks. If these cuts had materialised, then that would have been great news for longer-maturity, high duration bonds.

Lyon says that there will be fewer cuts, when they eventually arrive, which may imply interest rates settling at a higher level than many expect.

As a result, he continues to keep duration risk low, which he says served the trust well in 2022 where it avoided material drawdowns from rising yields.

Lyon adds: “We suspect there is a need to acclimatise to this new environment. Despite easy comparisons from price levels of a year ago, inflation has remained stickier than expected with core levels still stubbornly above targets in the US and the UK. This plays into our preference for holding inflation-linked bonds, which offer positive real yields.”

interactive investor completes fifth T-Bill auction

Fixed income watchers may have seen – or participated in – UK Treasury Bill auctions via the interactive investor platform.

Partnering with broker Primary Bid, which takes our orders to the Debt Management Office, ii allows customers to buy these zero-coupon bonds issued by the UK government.

Unlike gilts, they do not pay a coupon. Instead, they issue below their £100 redemption value, giving investors a capital uplift, with annualised yields currently around 5%.

The last offer closed this week, giving investors access to a three-month bill and a six-month bill. This follows on from two further six-month bills and a three-month bill that we have offered.

• Everything you need to know about UK Treasury Bills
• Benstead on Bonds: why gilt auction access is a win for small investors

One key advantage is that they offer a fixed rate for shorter periods than gilts, meaning that holding the instrument to maturity may be more feasible than for gilts, which can mature over long periods. 

Investors can therefore lock in a return similar to a fixed-rate savings account, and pick up their return when the bond matures without having to worry about market fluctuations. 

The return profile is simpler to understand than gilts, with all the gain coming on the maturity date and return of £100, whereas a gilt’s yield-to-maturity is a mixture of coupon payments and capital returns or loss when the bond matures. Another advantage is that bills can yield more than gilts maturing over a similar period.

Watch your inbox for more T-Bill offers. T-Bill auctions appear on our IPO page.