Fixed income was the best-selling asset class in the month of October with net retail sales of more than £2 billion, according to new data released by the Investment Association.
The sudden popularity of bonds raises a few questions, as it might be the case that investors are buying bonds ahead of an expected market correction.
According to Alastair Wainwright, a fund market specialist at the Investment Association (IA), October marked the fifth month in a row fixed income was the best-selling asset class. In addition, he points out for the third consecutive month sterling strategic bond was the most popular sector.
Bond funds are in vogue at a time when investors are turning their backs on UK shares. In October both the IA’s UK All Companies and UK Equity Income sectors experienced outflows. This is the sixth month in a row money has been withdrawn from the sectors. UK Equity Income was the worst selling sector overall over the month with a net retail outflow of £272 million.
Experts, including Darius McDermott, managing director at Chelsea Financial Services, are struggling to put their finger on why retail investors are buying bonds, at a time when bond yields are trading at historic lows.
Darius McDermott, managing director at Chelsea Financial Services, says: “I continue to be surprised by the flows into the [fixed income] asset class. With European high yield bonds being placed at lower yields than US treasuries you can easily see there is mispriced risk in the asset class.”
He continues: “The only reason I can fathom for the flows is that equites are also expensive. They are not expensive relative to bonds but are in absolute and index terms.” He adds that these statistics worry him and that he maintains a substantial underweight to bonds.
Jason Hollands, managing director at Tilney, is also concerned. He argues the move to buy bonds at this point in the cycle “could backfire as there is also a lot of mispricing in the bond markets as a result of years of abnormal policy.”
He adds: “I think this a sign of increasing nervousness around equity valuations and therefore retail investors are reaching for what are traditionally perceived as defensive assets.”
Further, Hollands says there is a potential political scenario that could play out in the UK which could spell bad news for the bond market. He argues that while continued flows out of UK equity funds are partially down Brexit uncertainty and the headwinds created to consumers by inflation ahead of wage growth, there are domestic political risks that come into play.
“Anecdotally we see wider political concerns being a factor as investors worry about a potential hard left Corbyn/McDonnell administration. These concerns will have been amplified significantly this week with the impasse over the future of the Irish border potentially stalling the commencement of UK/EU trade talks and renewed infighting within the Conservative Party around competing visions of post-Brexit Britain.
“The significant widening of the UK deficit implicit in Labour’s spending pledges would likely lead to another major leg down in Sterling in the event of change of Government, put pressure on the UK’s credit rating and lead to yet more inflation as the cost of imports rise. This in turn would likely accelerate monetary tightening, pushing borrowing costs (including mortgages) higher.”
He concludes: “From an investment perspective this scenario would be particularly brutal for UK gilts, where current 10-year yields of 1.23% are already negative in real terms after inflation (currently at 3%) is factored in. In that scenario, investors who have aggressively moved in sterling bond funds because of the perceived defensive qualities of fixed income, may remain exposed to the turbulence they seek to avoid.”