2016 has already been a historic year for the UK Government Bond market – the returns have been most unlike those traditionally observed of ‘low risk, low return’ government debt. The market was already performing strongly but has seen a further surge following the EU Referendum and the subsequent decision by the Bank of England to cut interest rates by 0.25%. The cut was in line with market expectations but the additional stimulus package of new quantitative easing measures went further than expected.
Yields fall when prices rise, so the effect has been to drive the yield to record lows. The rise in price has caused the yield on 10-year gilts to fall to around 0.8% and on 5-year gilts to below 0.2%. Investors wishing to tie up their money for 15 years can expect an annual return of 1.2% if held until maturity. For some overseas sovereign bonds, however, the prospective returns on offer are even worse, with more than $13 trillion of global government bonds offering a negative yield to redemption (whereby purchasers of these securities are guaranteed to lose money on the investment should they hold them to redemption).
The above is testament to various factors, including lingering fears of deflation, sluggish global growth, political uncertainty, and (most prominently) the aggressively loose monetary policies of major central banks. Many investors are now therefore avoiding gilts within their portfolios. Diversification is necessary and those wanting assets which provide returns that are uncorrelated to equities are seeking other, traditionally ‘higher risk’, opportunities within fixed income such as corporate bonds, preference shares and other, more esoteric, investments.
These are unprecedented times and investors should be wary of the significant downside risk presenting itself alongside ever-decreasing yields in bond markets. It may well be the case that yields remain negative or low for some years to come, but in the meantime such securities seem to offer “return free risk” as opposed to the “risk free return” that they have historically.