Bond prices have only one way to go – and that’s down, according to successful fixed income investor Bill Eigen. In fact things are so bad, that Eigen professes to never have been more nervous as a bond investor in his entire career – which includes the 1994 bond market crash.
Eigen called time on his own long-only bond fund when he recognised that the future looked bleak for the asset class. The fund manager said he did not want to have to call investors and tell them they could not afford to move house, or pay for their children’s education because the bond market had tanked. Instead he now runs an Absolute Return bond fund for JPMorgan, which can hold large cash positions and short the bond market.
“The common sense case for bonds is bearish,” said Eigen, speaking in New York this week. “The bond market is based on simple quantitative measures – if yields fall you will lose money in real terms because of inflation. If they go negative you are paying someone to look after your cash and you will lose money. If they rise, then prices will fall and you will lose money.”
After more than three decades of bond prices rising in the US, there is a supposition among investors that fixed income can only climb higher. Unlike equities which investors have come to understand suffer price fluctuations, bond markets are assumed to be a safe asset.
“A false market has been created in bonds by Central Banks,” says Eigen. “They have broken bond markets. Even when the economy grows and inflation rises, bond yields fall. This should not be the case. Fundamentals no longer drive bond markets – Central Banks do.”
The economies of the US and the UK have decoupled from the rest of the world since the credit crisis. These two nations have achieved positive economic growth, while Europe and Emerging Markets have struggled. And yet interest rates remain eye-watering low, depressed by the Fed and the Bank of England. These low rates then become the lowest common denominator – forcing the sovereign debt of countries experiencing significant economic challenges to also have super low rates; such as Italy and Greece.
“As an absolute return fund manager I can take bets on markets falling and rising and go to cash, and am able to look at things pragmatically,” said Eigen. “The market is not reacting to bond yields in a logical manner. Why are investors rushing to sign up to 10 year Spanish debt at 1.9% when not that long ago the yield offered was 8%? You are not being compensated for the risk you are taking on.”
Eigen is currently 55% invested in cash – so worried is he about the risks to bond markets.
“You are going to get to a point soon where long-only bond funds will not make money. You need to be able to short the market and if you don’t have that toolkit you’re out,” he said.
“Fixed income does not have the ability to make back losses like equities.”
Rates at All Time Lows – But they May Stay There
Whether Eigen’s doomsday predictions are correct or not there is no disputing that yields are at all-time lows across the globe. Rates have simply never been this low across the developed world.
Because rates are so low, if prices do start to fall investors have no yield buffer to protect them. If the value of your investment falls but you were being rewarded with an above inflation income it would help to protect you from this capital loss. But with record low yields this buffer does not exist.
Mark Dampier of Hargreaves Lansdown said that while over the long term he did not doubt yields would rise, investors did not need to panic as they may have quite some time to wait yet.
“Bond bears started predicting the bottom of the market four years ago – and fixed income investors have made quite a bit since then. I think it is more likely that yields may fall further, or they may stick at this level for a while, than we see a significant and rapid increase in bond yields.”
Wesley Sparks, Head of US Credit at Schroders, said that there were certain areas of the bond market that looked attractive, investors just has to be selective.
Speaking at a conference in New York, Sparks said that he was bearing on the front end of the yield curve – ie short duration investment bonds, but that 30 year corporate bonds looked good.
He also said that BBB bonds – the lowest credit rating included in the investment grade sector – were the most attractive, as they paid a healthy yield but did not have the default risk associated with high yield bonds.
Sparks echoed Eigen’s conclusion that central banks, rather than fundamentals, still controlled the bond market, both in terms of ownership and influence.
“Yields are pulling each other down, there is no pressure to offer a significantly higher yield on bond A when bond B pays just 0.7%,” he said. “I know there will be volatility, but this creates buying opportunities.”
