More than £150bn has been wiped off the value of Gilts since the start of 2022, the biggest fall in more than 30 years, as investors focus on rising interest rates, new research has revealed.
Gilts area type of bonds issued by the UK Government in order to finance public spending. Gilt prices will fluctuate from day-to-day in the market, depending on the outlook for interest rates.
The fall in value has also led to the digital asset manager warning of the implications of the reduction to the UK’s pension funds.
There are more than 40 million people who either pay into or are receiving an income from a pension invested in the stock market, the investments include shares, Gilts and derivatives of these.
Collidr said the biggest percentage fall in UK Government bonds since the 80s means the investment managers in charge of the UK’s £3trn pension assets will need to rethink a long-held tradition of holding a proportion of funds in what were considered safe assets.
It said the sell-off in bond markets could mean the end for the traditional 60/40 portfolio solution; this is where pension funds are ‘lifestyled’ to invest a proportion of the money into Government bonds when a person is nearing retirement.
There has also been a misconception that bond prices and the price of shares were uncorrelated, which led investors to believe that if shares fell then the bond element of their portfolio would offer a partial hedge against that fall.
Instead this year has seen shares and bonds fall in tandem.
This means that since 1 January to the of end April, Gilts have fallen by 10 per cent, the biggest drop since the 80s, compared to a fall of 6 per cent in the same period for the FTSE World Equity Index.
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As well as underperforming shares, gilts have also been more volatile than shares.
Since 1 January 2022, gilts have had a drawdown of 11.25 per cent (the percentage between its peak price and its lowest price)versus a drawdown of 11 per cent for shares (FTSE World Equity Index).
This has been a major challenge for many investors as they hold Gilts for defensive purposes, on the assumption that they will be more stable than shares.
Symon Stickney, CEO of Collidr, says this collapse in bond prices has put “another nail in the coffin” to the traditional, static 60/40 portfolio solution that many fund managers have developed for retail investors.
The was based on the principle that the 40 per cent weighting in bonds will reduce the risks and volatility of the overall portfolio.
However, bonds prices have become so overstretched that they have been vulnerable to rising inflation and rising central bank rates.
Collidr says the sell-off in bonds is the latest evidence that the 60/40 concept is too blunt a tool for investors.
Mr Stickney added: “Investors need to look at alternative asset classes to bonds if they want true diversification.
“At the moment, diversifiers might include strategies like long/short equity, market neutral funds, currency trading and assets like commodities, oil and real assets.
“Investors should also be looking at large-cap quality companies with brands that customers can’t live without – those are the kinds of businesses that should perform better as rates rise and have the pricing power to help offset the impact of inflation.
“For investors looking to offset the volatility of equities, bonds are not the answer at this point in time.
“The sell-off in the bond markets is causing big challenges to fund managers. Few individual fund managers have actually worked through a fall in the bond markets of this scale.”
Adam Walkom, co-founder at Permanent Wealth Partners said his company had long been concerned about Gilts and other bonds because when interest rates were at zero, there was only one direction of travel possible.
“We have been raising this issue with our clients for months and moved many out of the classic 60/40 portfolio for this very reason. The real issue is still yet to be realised and will be felt by people who have ‘lifestyle’ pensions, which is how the majority of employer pensions are set-up today.
“These pensions automatically ‘derisk’ into gilts and cash as each person approaches their retirement age because, according to the same theory as the 60/40 portfolio, it’s meant to be safer. These people now face significant capital losses on their supposed safer pensions. This is a hidden time bomb within the pensions industry that is just waiting to blow up.”
However, other experts say it is nothing to worry about.
Joshua Gerstler, chartered financial planner at financial planners The Orchard Practice, said: “Most long-term investors will have a well-diversified portfolio consisting of various asset classes including shares and bonds.
“If you are overexposed to bonds at the moment you will be seeing a drop in your portfolio, much the same as you would be if you are over exposed to shares.
“The important thing to remember is that you are investing for the long term and that any short-term volatility is the trade off people have to accept in return for the long term gains.”
Philip Dragoumis, director and owner at Thera Wealth Management, added: “Gilts have had a rough 2022 so far but this should be put into context against the highest inflation rate since 1982.
“The Bank of England has to respond by raising base rates and yields have risen from a very low base, as interest rates were cut in the pandemic. A torrid four months is not enough to pronounce the death of the 60/40 portfolio solution, which has been working for decades.
“This is a unique set of circ*mstances just as the pandemic was an unprecedented and unexpected event. The Bank of England believes inflation is being driven by external factors and sees it as transitory and falling over the next two to three years.
“Higher prices will hurt demand as we have seen in the UK consumer confidence survey, which has hit the lowest level since 1974.
“Inevitably, recession looms as consumers reign in spending, and higher interest rates dampen demand. Bonds then start to look attractive again, especially the long end, as the yield curve goes negative and the market expects interest rate cuts in the future.”
