Bonds regain some sparkle after grim reset

Every cloud has a silver lining, and all that. Yes, the government bond market is on course for its worst year since 1865, according to Bank of America.

“It has been a grim environment overall,” as Andrew Balls, Pimco’s global chief investment officer for fixed income, drily put it at the end of last month. “This has not been a particularly fun period for anyone.” Quite. Sky-high inflation and rapidly tightening monetary policy are not a friendly mix for most asset classes.

But the happy news is that the ugly drop in bond prices has finally slayed Tina — the There Is No Alternative mantra that has dominated financial markets, particularly since the start of the pandemic. Under this mindset, investors have for years convinced themselves it makes sense to buy ever riskier assets in search of decent returns because so-called core bond yields, on debt issued by countries with rock-solid credit scores, have been so low. Tina made me buy growth stocks, Tina made me buy cryptocurrencies, and so on.

Well now it turns out there is an alternative after all. For the sake of argument let us call it Buying Ordinary Notes and Debt Securities — BONDS.

The historic beating administered to debt markets so far this year means that some core bond funds, such as the one managed by Balls at Pimco, are now offering returns in the region of 5 per cent. Sure, that is below the rate of inflation in pretty much any developed country. But it certainly sounds more appealing than high-tech growth stocks (Nasdaq stocks have fallen about 26 per cent this year, or crypto (down 55 per cent), or putting your cash in a bin and setting fire to it, which is roughly the same thing. Remember to use metal bins, crypto bros.

“When you have 5 per cent yields on a core bond fund, that starts to look pretty good,” says Balls. In comparison, as prices hit a peak in the bond market, about $18tn in debt had negative yields. Investors who bought them were signing up for losses. So lots of investors had to stray into spicy assets to deliver the returns they needed.

Now though, that long-lost yield is popping up all over the place. US investment-grade debt now yields about 5 per cent. High-yield debt, meanwhile now gives a, well, high yield, in the region of 9 per cent, more than double the level of this time last year. Yields on riskier European corporate debt now stand at over 7 per cent, from well under 3 per cent a year ago.

Higher borrowing costs are definitely a bitter pill for companies to swallow — but for investors, happy days. There is no free lunch in markets. Companies default sometimes, especially in recessions. Flaky market conditions in times of stress mean that sometimes, even if they want to, fund managers cannot get their money out of corporate debt in a hurry.

But the equation has shifted. “You are getting paid to be a lender now,” says George Bory, chief investment strategist for fixed income at Allspring Global. “The market has repriced to the point where you are being paid to take risk.” Just like the good old days.

This is catching the eye of investors who do not normally look to the supposedly dreary bond markets.

Alex Veroude, chief investment officer for fixed income at Insight Investment, says some of his clients are already sniffing around. “We have had a reset in the fixed income environment here. For now, the biggest actions have yet to be taken, but the conversations we’re having with large institutional investors suggest you are going to see large asset allocation changes coming through in the next 12 months.”

One client, he says, is considering flipping a multibillion-dollar portfolio out of growth stocks and into debt markets. This is a tough decision — it means giving up on a conviction and crystallising losses on equity holdings. Still, some equity investors, and debt investors who ventured into riskier territory to try and eke out a decent rate of return, are considering heading to safer ground with a promised stream of income.

“Your home base is to get to 5 to 7 per cent with as little risk as possible,” says Veroude. “Minimising risks is central to investing. If you can get the same or target returns with less risk, you should think about that. Do I need to be invested in, I don’t know, Bolivia? Do I need to be in deeply subordinated commercial mortgage-backed securities?”.

Maybe not. Maybe safe, plain vanilla corporate debt, with a regular income stream, is your friend after all.

It does not look like a wholesale shift out of equities and into bonds is happening yet, to put it mildly. In a recent analysis of flows in and out of mutual funds, Goldman Sachs noted that bond funds have taken a “steep” path lower, far eclipsing equities, with only two weeks of net inflows so far this year.

But if investors do take the plunge and bet on boring old bonds, we will have another addition to the long list of reasons to avoid the risky stuff that made little sense in the first place.

katie.martin@ft.com